By Jonathan Burton
“I’m about as bearish as I’ve been since 2008,” says Hedgeye’s Keith McCullough. It directs investors to silver, gold and other defensive games.
Keith McCullough, founder and CEO of Hedgeye Risk Management, isn’t one to mince words when talking about financial markets, the Federal Reserve or the economy.
Right now, he has a few less than charitable things to say about how the Fed’s rate hikes have boosted stock and bond investors.
Economic models from his investment research firm turned bearish on stocks and bonds in early 2022. Prices have since fallen, but McCullough is still bearish. It is now directing investors into defensive positions primarily in cash, US dollar, gold and income-producing stocks.
McCullough is preparing investors for the painful recession he expects for both Wall Street and Main Street in 2023, he said.
Even if the Fed were to give in, McCullough says the damage is done. “They’re way too late,” he says of the Fed. “Just as it was impossible for them to stop inflation, so it is impossible for them to stop the impending US corporate earnings recession or the main recession.”
In this recent interview, which has been edited for length and clarity, McCullough outlines his baseline scenario for the US economy and financial markets heading into 2023, and advises investors to take shelter. of a coming storm that many of them have never seen.
MarketWatch: In a MarketWatch interview last April, you said that “the Fed always makes mistakes” and predicted a bear market for US equities this summer. That happened. What do you expect from the Fed now: learn from its mistakes or do more?
McCullough: Today’s recession is what “transitional” inflation was a year ago. The Fed is as much wrong about the risk of recession as it is about inflation.
I’m about as bearish as I’ve been since 2008. Instead of a soft landing for the economy, I think it’s going to be a hard landing. The recessionary economic data continues to worsen, not only in the United States but also in Europe.
Free money has forever created behavioral problems and a behavioral bubble for markets and investors. You think you will have unlimited access to easy money and behavior whether you are building non-profit growth businesses through storytelling or cryptocurrencies that are also just stories. You come from the mother of all behavioral bubbles that will now be dealt with on a tighter budget. When you print money and the economy accelerates to the fastest growth rate ever, you are going to have the mother of all bubbles. Now the GDP will slow down to zero, and you get the opposite.
Read McCullough’s April 2022 interview: ‘The Fed is still messing around’: This forecaster sees US stocks in a bear market by summer
MarketWatch: A hard economic landing and an economic environment echoing the 2008 financial crisis is a pretty damning verdict. You’re not on the permanent bear side with some forecasters, so what do you see now to have such a pessimistic view?
McCullough: On many levels, it’s worse now than 2008. If 2008 was Wall Street’s collapse in on itself, with all its conflicts of interest and lies, this one is more about Main Street. The main street is mowed. Main Street takes all that inflation into their cost of living. Main Street has had the highest interest in credit cards since the 1990s. It’s much worse than 2008 on that basis. If you try to pay your bills on credit, it gets worse and worse. And then they will lose their jobs. Labor collapse is always the last thing to fall. We are at the dawn of a work cycle that is going in the wrong direction.
This is what is happening right now. Both GDP and earnings growth are negative. The Fed will see all of this and will have to change. The big problem people will have is that the minute they see the Fed’s dovish attitude, they will buy stocks and cryptos. Then they’re going to realize they’re in a recession, which is an entirely different setup from what caused those bubbles to begin with, which was unlimited easing and fiscal support plus GDP growth.
We have an economic deceleration regardless of what the Fed does. It is impossible for the Federal Reserve to stop gravity. They are far too late. Just as it was impossible for them to stop inflation, it is impossible for them to stop the impending US corporate earnings recession or the main recession.
MarketWatch: It’s not just the Fed that could miss signs of recession until it’s too late. Stock market investors could also find themselves on the wrong side of the track.
McCullough: First the Fed has to realize that what I’m talking about is the high probability event. It will take time. It won’t take them a month. They need to realize that we are in a recession and then pivot policy accordingly. Then when the Fed gets dovish and realizes we’re in a recession, that’s bad for the stock market.
The Pavlovian response is that the Fed is dovish, buying stocks. That’s true if you’re not in a recession. This coming recession – which could be the biggest earnings recession of the modern era – will be quite an education for people who are still optimistic, in the hope that the Fed will save them.
MarketWatch: Many Fed watchers and market analysts expect the Fed to suspend or slow rate hikes to gauge the effects of its inflation-fighting efforts. Do you see a “Powell pivot” coming?
McCullough: There is no accommodating pivot. The level of inflation is far from the Fed’s target. And midterm elections are approaching. They have already established that the rate hikes will go until November. Rate hikes are baked into the cake and anyone who wants this to turn into birthday cake for the bulls will be sadly disappointed.
An entire generation of Americans has not been through a recession. Many Silicon Valley companies have never been through a recession, for example. My definition of a US corporate earnings recession is when the rate of change in earnings growth has turned negative and the rate of change in year-over-year earnings growth has turned negative. The Federal Reserve, even if it were to become accommodative on interest rates tomorrow, will have difficulty stemming the recession in profits.
When the economic rate of change accelerates and the Fed prints money, you buy anything with a good chart and a good story. You are going to make a lot of money until the music stops.
And he did. Now we see the opposite. The rate of change in real GDP growth and inflation is slowing down at the same time. You cannot own inflation, commodities or growth now. If you are still long in pretend growth or growth without profit or crypto, I recommend prayer.
MarketWatch: Given the grim picture you’ve painted, where are you asking investors to put their money to weather the storm?
McCullough: There aren’t many places to hide. Our largest equity position is in utilities. Utilities is a bond proxy. We still love gold.
If you must own stocks, we like quality balance sheets, profitable companies that have high-quality cash flow. We’ve run out of growth – all of it. We lack technology. The energy values are drawn up on the long side. I’ll take my time on this. It’s a place I’m interested in buying, but currently we’re only long in natural gas, Master LPs and solar through the Invesco Solar ETF (TAN). We are bearish on oil, copper – all major commodities other than natural gas. We are short in Europe on the equities side and the euro. I’m in no rush to cover these shorts. The trend is down for equities and up for the US dollar.
Also treasuries, but you have to wait, watch and act as the game unfolds. If the 10-year US Treasury BX:TMUBMUSD10Y falls below 2.95%, it’s a pretty obvious green light to make long-term Treasuries one of your main asset allocations. Many people try to bottom out in stocks. I’m much more interested in buying treasuries than anything else.
Also read: ‘We’re in big trouble:’ Billionaire investor Druckenmiller thinks Fed monetary tightening will push economy into recession in 2023
Plus: It was the worst September for stocks since 2002. What it means for October
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