We continue to believe that the likelihood of a recession in 2023 is someplace between absolutely certain and virtually guaranteed. Our recession model has been signaling that for a while now as economic demand continues to erode due to tighter financial conditions. Tighter financial conditions (the combination of higher Fed funds rates AND the Fed shrinking their balance sheet) has been aimed at destroying economic demand since last May. It’s unpleasant but it’s working. Container freight rates down -80% since then, trucking rates -35% since then, and natural gas prices -70% since then. Demand down, prices down.
The UST yield curve finally inverted last fall – an excellent predictive tool of coming recessions 12-24 months forward. That’s the chart below. An economic recession is a comin’… and for our regular listeners that should not come as a surprise. Usually during the first twelve months of a yield curve inversion, the equity market continues to chug higher as investor sentiment remains elevated/giddy. However, now 35 months into the bizarre cycle, we now realize that this cycle isn’t like any other cycle. This time the equity market went down PRIOR to inversion and investor sentiment is already someplace between somber/despair. Put another way, we believe the economy gets an economic recession in 2023 but the market already had its recession in 2022.
The implication for portfolios is that risk can and should do well even as we make our way thru this economic slowdown because valuations experienced a major reset already last year and investor sentiment has been obliterated. The biggest area to avoid remains lower quality credit and the high yield bond market in general. That’s where bond defaults will occur when we officially get our 2023 recession. History says the best time to buy that asset class is right during a recession. That timing will likely be mid-2023. Patience all – high yield distressed will likely grow much more attractive mid-2023 but only after a slowdown and only after bond defaults have forced HY bond prices lower.
Chief Investment Officer
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