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War, Inflation, Interest Rates: Is a Recession Coming?

June 9, 2022

War, Inflation, and rising interest rates. Is a recession coming? "Not in the cards," according to Golden Eagle Strategies. Learn about the real culprit behind inflation, what we fail to keep in mind when addressing the rise in interest rates, and why stocks still trump bonds.

EYE ON THE STOCK MARKET: EPISODE #1 - TRANSCRIPT

Welcome to our Eye on Market Trends segment featuring macroeconomic and stock market commentary grounded on facts, not opinions. Robert Zuccaro, Founder & CIO of Golden Eagle Strategies, shares his thoughts on war, Inflation, and rising interest rates. Robert is a quant pioneer driven by a never-ending pursuit to identify the common threads of top-performing stocks in pursuit of superior performance. He is also a prolific writer and author of the book How Wall Street Reshaped America’s Destiny.

QUESTION 1: What is your perspective around the war, inflation, interest rate, and are we headed into a recession?

As you mentioned, investors are concerned about war, inflation, interest rates, and recession. Since 1940, there have been 18 major geopolitical events, many involving war. The US was bombed at Pearl Harbor on December 7, 1941. It took the market one year to recover. After it went down, after the new Cuban Missile Crisis in 1952, it took just two months for the market to recover. On average for these 18 geopolitical events, the market has recovered 47 days from the onset of these events. So the Ukraine war is somewhat serious. It's causing economic dislocations throughout the world. But the United States, of all countries throughout the world, is best positioned to deal with this war, which more than likely will come to a conclusion over the next few months.

On inflation, we published and sounded the alarm almost a year ago, in July of last year, in an article that we published stating, 'Transitory Inflation is Wishful Thinking". Since then the rate of inflation has continued to ratchet up. The recent report on the CPI puts us at an 8.5% annual rate. Our work shows that inflation is actually understated as reported by the Department of Labor. And it's a serious problem. Most commentators look at the causes of inflation as being supply bottlenecks, and the onset of the war, which started in February, but inflation was escalating at higher and higher rates well before the war started. The real culprit behind inflation and why we think this is a years long problem. - it's not transitory, it's embedded into the US economy for this reason - from the end of 2018.Through two months ago, the money supply M2. which means the aggregates of cash and savings accounts. expanded over less than two and a half years by unprecedented 42%. And it expanded in one period at a far faster rate than any year during World War II. This is the real catalyst behind inflation and it's the reason that inflation is not going to come down anytime soon.

But American business is ingenious. In the 1970s, they adjusted to very high inflation, which crested in 13.3% in early 1981, and continued to make adjustments in their businesses in order to improve corporate profits. The same thing will occur this time around. Inflation and interest rates are causing concern. And what we fail to keep in mind in addressing the rise in interest rates, and the Fed now has raised rates twice, you have to hold the rate steady for many years and we are starting from a base of historically low interest rates. And there is more than ample room for the Fed to raise rates in order to dampen economic activity. If you look at the long term, the average yield on a 30 year treasury bond has averaged 4.5%. Over the last four years, we are now at 3.2%. And again, if interest rates are not a problem, they will go higher, they must go higher in order to dampen economic activity, bring inflation under control, but they do not pose a major threat to the US economy.

In terms of recessions, I don't know why people were talking about recessions, they're talking about inflation, rising interest rates, wars. There have been 52 business cycles since 1854. Three of the four business cycles have occurred in the last four economic expansions. The 1990s witnessed a 10 year expansion, followed by a recession followed by a five year expansion in the early 2000s. The last economic expansion from 2009 to 2020, was the longest on record, lasting nearly 11 years and would have gone on longer had it not been interrupted by an exogenous event, the pandemic. Those people that are talking about recession means that whenever we have a recession in next year, it's going to occur within three years of the start of the last recovery. I do not think that's in the cards, because of government stimulus.

The economy has been overstimulated. In December of 2020, in the Trump administration, Congress passed a stimulus bill of $2.3 trillion. Two months later, 60 days later, the incoming administration passed another stimulus bill, one calling for an ancillary $1.9 trillion under the American Rescue Plan Act. Clearly, there is too much money in the economy at the moment, however, consumers are flush with more than $1 trillion in cash and savings account that at some point will find its way into the savings stream. So the way that we look at it, and most people fail to recognize that the stock market is a leading indicator, typically turning six to 12 months before a turn in the economy, either up or down. They look at the current news and they equate it with the current stock market. The stock market does not work that way. More than likely, it has discounted a possible but unlikely recession over the next 12 months, in our view. We think we are at the worst point in the market, and by year end, the economy will still be expanding. And we will looking be looking at a higher stock market.

 

QUESTION 2:  What are the key takeaways for investors?

Key points: The profound expansion of the money supply, which few people were looking at, which means that we are going to have persistent high inflation. Second, the war is disruptive, but it's not going to determine, to a great extent, the American economic activity, the American economy over the past 5 and 10 years has been done better than any of the stock markets and economies throughout the world. And that will continue. The bad news is behind us in the stock market. The NASDAQ is down 30%, the R2000 is down 21%. And recently, a couple of days ago, the S&P was flirting with being down in bear market territory. Almost 20%. Now this is important" No one knows which way the next 20% move in the stock market will be. But everybody knows which way the next 100% move in the stock market will be. Our mantra is that bear markets a temporary. Don't worry about them. Don't panic, don't do anything differently. But the bull market is permanent.

I'm going to give you some additional information for thought. I don't think investors should own bonds. I think bonds are a silly component of the portfolio. If you bought a 10-year bond 10 years ago, you would have had a coupon of 3.2%. Over 10 years, how much did that coupon change? It's fixed. It's a contract. Ten years ago, the S&P 500 was paying out $23 in dividends. Last year, it paid out $57 in dividends. That's a bump of 146% and a very compelling reason to own stocks, because there's growth in profits and growth in dividends. Profits go up on average, four every five years in dividends of company growth and profits. So you have intrinsic growth in profits and dividends, and that's because of the ingenuity of American businessmen and womein - both corporate people and entrepreneurs. And we have 20 million small businesses in the United States which account for half of the economic activity, and the other half is accounted for by corporate America.

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This transcript was generated by software and may not accurately reflect exactly what was said.

Please note, that the thoughts expressed in this podcast are those of the presenter. This is not, nor should it be considered an offer or a solicitation of an offer for investment.

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