What Goes Up

Brace for a US recession to start next quarter and worsen at the end of the year, and don’t bet on the Federal Reserve to react immediately to prop up growth. That’s according to Sarah House, senior economist at Wells Fargo & Co. She joined the What Goes Up podcast to give her appraisal of the economy, and discuss what to expect for the rest of 2023.

“It’s likely to be kind of more of a slow drag in terms of economic activity, just given that we also don’t think the Fed’s going to be riding to the rescue as soon as you do see that weakness,” she said on the podcast. “The nature of the inflation that we’re seeing right now, we think that the Fed’s actually going to be pretty reluctant to ease policy even as the economy is entering a recession.”

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While the drama surrounding regional US banks has largely subsided following the failure of three lenders in March, that doesn’t mean the ripple effects of Federal Reserve interest-rate hikes are over. This is according to Que Nguyen, chief investment officer of equities at Research Affiliates, who joined the What Goes Up podcast to give her outlook on markets and talk about why she doesn’t foresee a soft landing for the economy.

“When the Fed raises rates and it breaks something, it rarely happens that it’s a very small break,” she says. “Usually it’s a very big break. And so while I’d never thought that we would get to a great-financial-crisis level of breakdown, I do believe—and I did believe, and I still believe—that there would be more things that break. Whether that continued to be in the small regional banks or whether that bled over to something else such as real estate lending, private credit—definitely those dangers still remain out there.”

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Runaway inflation. Surging interest rates. Bank failures. For a while it seemed like all of these issues would combine to trigger a US recession. Not so fast, says Morgan Stanley’s Seth Carpenter, the bank’s global chief economist. He joined the What Goes Up podcast to explain why there are signs the US could experience a “soft landing” that averts a major economic downturn. 

“It seems hard to avoid the fact that the US economy is going to slow down, and part of the reason why that’s hard to avoid is because that is absolutely, categorically, by design the Fed’s objective,” he said. “We think they’re looking carefully at the data and asking, ‘Do we have enough evidence that things are slowing down a lot, but not yet crashing?’ Because that’s what they’re looking for in order to stop the hiking cycle. So we think the last hike is in May, when there’ll be more evidence of a slowdown, but not yet evidence that things have actually fallen off of a cliff.” 

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Troy Gayeski, chief market strategist at FS Investments, says don’t wait until May to flee the stock market rally—get out now. He joined the What Goes Up podcast to explain why he’s expecting the S&P 500 to bottom out at around 3,200, a roughly 22% drop from current levels.

“First of all, the strongest rallies have always been in bear markets,” he says. “Usually they’re driven by technical factors. And then there’s a narrative that’s put together to justify it: the more recent one was that inflation’s going to slow enough that the Fed won’t have to hike anymore, and then we’re going to have a recession and somehow that’s going to cause the Fed to cut rapidly. But recessions aren’t bad for revenue or earnings? It really makes very little sense.”

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It’s not just the prospect of deteriorating fundamentals that has Man Group’s Mark Jones skeptical about stocks these days. It’s also the risk of money flowing into fixed-income investments now that they’re sporting attractive yields. Jones, who is the deputy chief executive of the world’s largest publicly traded hedge-fund manager, joined the What Goes Up podcast to give his outlook on markets and explain what strategies have been working well at his firm.

“I think the risk-reward in equities is very, very tough at the moment,” he says. The first reason is a potential further cut in earnings expectations. Second is the flow of money into alternatives to stocks such as government bonds and corporate credit. “Whether that’s the consumer or whether that’s big institutional clients starting to come back to an asset class that, frankly, had fallen relatively out of favor, some of that flow of funds is also an issue for equities as just people move money around.”

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If there’s one thing that keeps professional investors up at night, it’s being involved in a “crowded trade.” In other words, a position that’s become so popular that there are few investors left to get involved with it, so there’s risk of painful losses for all if the crowd heads for the exits.

That’s part of the appeal of microcap stocks for Patrick McDonough, a portfolio manager at PGIM Quantitative Solutions. He joined the What Goes Up podcast to explain his approach to analyzing these smaller, younger companies whose values are often measured in millions, rather than billions, of dollars. Since many investors are more comfortable with bigger, more-established companies, microcaps offer a unique and overlooked source of growth.

“It’s something that people have historically avoided,” McDonough says. “Which means it’s not crowded. So it’s an area we can go in and get a lot of upside.”

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When Steve Sosnick recalls 2008 and tries to make parallels to the current turmoil in the banking sector, one memory sticks out: riding the elevator with Thomas Peterffy, founder of Interactive Brokers, who offhandedly asked him “what’s new?”

“And I said, ‘what’s really interesting to me is the story that I’m reading this morning about how Bear Stearns may have as much as $20 billion in losses at some of their hedge funds,” recalled Sosnick, who’s currently chief strategist at Interactive. “And he said, ‘what’s their market cap?’ And I said, ‘I think about $20 billion.’”

“‘Are you telling me Bear Stearns is broke?’” Peterffy asked. Sosnick recalls saying, “‘I guess I am, aren’t I?’”

Sosnick joined the What Goes Up podcast to discuss what lessons from the 2008 financial crisis can be applied today. Though the current predicament isn’t similar to that period—banks are in much stronger positions and the economic backdrop is vastly different—it’s important to keep lessons learned in mind, he says. 

“They say history doesn’t repeat, but it often rhymes,” Sosnick says. “And I think there’s a certain rhyme to it, but we’re not there yet. And I certainly hope we don’t get there.”

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Torsten Slok had been firmly in the “no landing” camp of economists. More positive than a “soft landing,” its adherents say the Federal Reserve will tame inflation without triggering a recession at all. But for Slok, chief economist of Apollo Global Management, that all changed with the failure of Silicon Valley Bank. Now he’s bracing for a “hard landing.”

Slok joined the What Goes Up podcast to discuss the sizeable role regional banks play in the US economy, and the reasons why SVB’s collapse changed his outlook. A big reason is how regional banks may now change their behavior.

“Regional banks make up 30% of assets and roughly 40% of all lending,” he explains. That big chunk of the US banking sector is now looking at what happened to SVB and worrying what comes next. With a slowdown potentially underway thanks to the central bank’s rate hikes, Slok warns a reluctance to lend by SVB’s mid-size brethren might mean it comes “faster simply because of this banking situation.”

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Jeremy Grantham blames the US Federal Reserve for creating a bubble in asset prices—one he says has a long way to go before it’s fully deflated. As a result, stock prices may not reach bottom until late next year, he warns.

The 84-year-old co-founder of investment firm GMO joined the What Goes Up podcast to explain what he calls the current, “meat grinder” phase of the market, and why he believes the central bank has “hardly gotten anything right.”  

“Since Alan Greenspan first arrived—Paul Volcker knew what he was doing—but since then it’s been a long, continuous horror show,” Grantham says of US monetary policy. “They’ve engaged in policies that drive up the prices of assets, other things being even, and create spectacular overpriced bubbles. They then break because that’s what bubbles have to do. They simply break of their own extreme overpricing, and we pay a very tough price.”

Grantham also discusses broader market risks, including shortages of labor and natural resources, the climate crisis, de-globalization and a new version of the Cold War. “All of these long-term factors are beginning to bite,” he says. “This will make this particular down-leg more dangerous, and perhaps worse than we anticipated.”

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Princeton University’s Alan Blinder is one of the most prominent economists to have expressed optimism that the Federal Reserve can engineer a so-called “soft landing” for the US economy—taming inflation without triggering a recession.

But Blinder, who served in the 1990s as a vice chair of the Fed and a member of the president’s Council of Economic Advisers, explains on this episode of What Goes Up why he’s toned down his assessment. A big reason is the change in the way the Bureau of Labor Statistics adjusts inflation data for seasonal factors, he says. The result is that, while inflation moderated in the second half of 2022, it didn’t cool off as quickly as previous data indicated.

Blinder says that means there’s reason to expect more rate hikes from the Fed. “I think they still have a chance” at a soft landing, he concludes, “but it's a tougher chance than it was.”

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