Market outlook – inflation, recession, and opportunities

This is one of those “more important” blogs, folks. Its a bit longer than normal, but its important. Take the time to read it. I’ll draw on current and historical developments and present how we at ValueTrend are currently playing this market – and the “what if” questions we are asking ourselves. Our base case is – inflation is going to remain higher than expected, although it will eventually recede to some degree. Rates will go up more. Recession is highly likely – and that  – believe it or not- spells opportunity. In the meantime, I hope you subscribe to my regular blogs and have paid attention to this summer’s Bear-o-meter readings. If you have, you are smiling, and have remained holding cash despite the head-fakes that I warned you about.

To start:

North American governments try to blame inflation on external problems such as Putin’s war and the supply chain . While these factors certainly are part of the inflation problem – the basis of inflation is always an economic one –aka a supply/demand issue. Issuing debt and adding increasingly higher money supply – with no corresponding increase in GDP enhancing programs – exasperates the problem. You have more money, but you aren’t producing more. So you’ve thrown gas on the inflationary fire. Simple stuff really. I recently quoted numerous qualified economists in this blog on that reality. I also highly recommend dedicating 5 minutes or so in watching this YouTube by Brian Lilley

Our current problem can be described like this: Picture a $100,000 loan you take out from the bank. You spend that money on fabulous vacations. You renovate your cottage so its a comfortable place to hide. You give to the WE or Aga Khan charities in return for “favors”.  You finance a gender study. You support your favorite failing or crooked companies like SNC and BBD.

You didn’t increase your personal GDP (income) by doing any of those things, even if some of your decisions made you feel like a good Samaritan. And now, you owe the principle and interest on your loan. But – You still have the same income as before. So you’re worse off financially. And now you hear a recession is coming – which you aren’t prepared for. You may have to borrow more to get through it. The never ending circle.

Or….. you could have invested the $100,000 with an eye on the future. Say, in education for a better job, or an expansion of your business.

Now, you’ve increased your GDP (income). You’re better off financially. You saved and invested the extra income, and you paid off your loan. You’re prepared for the worst.

Our problem now is that we have tons of  borrowed money in the system, and it wasn’t “well spent” on GDP-positive programs. And then, along came the supply chain problem. We’re in an inflationary environment and staring at a recession because of this perfect storm.

For information on how the BOC has been irresponsibly printing (yes, printing) money – please read the last 2 pages of Thackray’s recent market report.

Inflation & recession

Here are quotes by people much smarter than I on the struggle to tame inflation, and the inevitable repercussions of bad spending:

“What makes it (inflation) sustainable? Inflation has a traditional pattern: an exogenous shock (war, pandemic, oil embargo, what have you); followed by the rise of the power of labor in the form of wage inflation; followed by the government mucking things up.” BearTraps

“Rates rising toward the higher end of the 4.5% to 6% range … will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it.” Ray Dalio

“We estimate it would require a deep recession in the U.S., with around as much as 2% hit to growth in the U.S., and 3 million more unemployed, and an even deeper recession in Europe.” Jean Boivin and Alex Brazier of BlackRock

The good news: Recessions spell opportunity for investors with cash

Craig and I have a knack for spotting and profiting from government BS – like here.

In 2021, when NA governments delivered their “transitory inflation” talk, most of Bay and Wall Street bought it.  We took the opposite view and called that BS out. We believed inflation would last, and commodities like energy were the place to be. We were right. Then they finally admitted entrenched inflation is a problem – and commodities rallied.

Then we heard that they didn’t anticipate a recession. We called that BS out, too. I suggested on blogs early this year to lower beta and hold cash. Well, here we are, and its finally being accepted that recession is pretty much a given. In fact, the talk of late is they will invoke recession to fight inflation. Damn the torpedo’s…

So why is that good news?

The global economy has experienced 14 global recessions since 1870: in 1876, 1885, 1893, 1908, 1914, 1917-21, 1930-32, 1938, 1945-46, 1975, 1982, 1991, 2009, and 2020. I’ve marked every recession from 1900 on the DJIA chart below.

Note how recession years mark the bottom of the stock market!  When the recession was extended by more than a year, it wasn’t until the final year of that recession that we saw a market bottom. These were the 1917-21, the 1930-32, and the 1945-46 recessions. Will this recession be one of the longer ones?

Modern (aka after the 1930-32 depression) market reactions to recessions have been relatively short and mild, and quick to turnaround.  This due to new supportive social and banking government policies invoked by President Roosevelt from lessons learned during the Great Depression. The exception was in 2009, and the banking collapse – a situation that had some commonalities to the Great Depression.

In some cases, recessions lasted less than a year. If we compare the 2009 recession to the 2020 COVID recession, we will see that in 2008/9 the damage was drawn out longer, with a capitulation washout Q1 2009. Contrast the 2020 recession. It was one-and-done in the first two quarters.   Thereafter the market rocketed forward in anticipation of recovery.

In most recessionary environments, the market reaction was that of a quickening market reversal when the recession was fully entrenched.

So….Now we wait for the pain. Rothschild said:

“The time to buy is when there’s blood on the streets”. 

But you need cash to do it.

Good news for the markets: Recessions – when fully acknowledged – tend to coincide with the bottom, then turnaround, for the market. This chart illustrates that fact. When a recession is finally in full force, the Fed will act to stimulate. It has in the past, and will again. 

Bull, Bear, or Base?

My recent video is part of the research I am presenting here (so please watch it)

The video presents some early evidence as to why June may have been a capitulation low point on the markets. Could that low be taken out? Sure. Markets could make a lower low. But there are signs to suggest that instead, we may have seen the lows in June – with retests of 3600-ish instead of declines below that level.

I am pondering on whether we may have entered into the highly volatile, but necessary, basing period that will lead into a positive market. Again- see this video to examine technical indicators that offer some clues as to why we may have seen the lows in June.

Having said that, as I always teach in in this blog and in my online course: We need to focus on what the market is DOING, not what it MIGHT do. You can’t predict. you can prepare! The charts tell us how to act. Maintain an open mind to any outcome.

The chart below tells us we are still trapped in a bear channel (red channel lines). The support/ resistance line around 4100-4200 seems to be holding the market down (with the exception of the brief August spike to the top of the trend channel).

So long as we see the June lows of 3600 hold, and the area between the upper trend channel (4250-ish) or current resistance of 4100 aren’t cracked to the upside – we are in a base. So:

• If 3600 is broken, we are still in a bear.
• If the trend channel breaks to the upside ( a moving target currently 4250), we have entered a bull market.
• If neither cracks, we are basing

Here’s a chart from Credit Suisse. It tries to predict the path of the current bear based on “average” historical patterns.

I am not a fan of this type of chart. Instead, I prefer more specific comparatives vs “all” bears. Specifically –  newsletter subscribers received a research report where we compare the modern era to the last era of inflation in the 1970’s.

Moreover, markets have a shortened recovery phases since the 1930 crash — again, see the long termed DJIA chart at the top of this blog.

So —  I don’t have a lot of faith in this type of “average” comparative. But for kicks n’ giggles, it suggests more downside before the final washout:

What do we buy when the time is right (whenever that is)?

This bear will end. It may result in a nicely swinging base. Perhaps we’re in that base now. Or we enter a new bull if there’s a breakout. Or, if 3600 cracks, the bear is still at large for a while. Be open to anything. Don’t fight it. Profit by it. Watch the charts. Don’t predict. Do prepare.  Have a plan to deal with any of the 3 scenario’s . Bull, Bear, or Base. Doesn’t matter which. You can profit, or protect, according to that reality.

In any case, there are sectors to consider as if and when the time is right for the bear to end. On our recent “Ask us Anything” video, I posted a chart noting the areas I see as technically attractive for a potential investment opportunity as the bear ends. Again – watch the key market levels noted above to get a handle on whether we are in a bear, base, or bull. These are future ideas, not current ideas.

In a nutshell, I like: Commodities, Value stocks, China, and certain emerging markets. Here is the chart I posted on the video – you can watch the video for better details on why I like them:

Commodities & inflation

If we remain in a higher than normal inflation trend (lets say 4% vs the Fed target of 2%)  you may want to hold some commodity exposure in your portfolio – or at least trade in and out of them as we have for the past 3 years. We’re light now, but we are keeping an eye on the charts. Producers of commodities can be attractive. Think of it this way: producer stock shares are claims on the profits from assets that are being produced. They represent partial ownership in companies producing “stuff”. Inflation increases the prices of “stuff”. You own a proportionate share of ownership of that “stuff” – and the profits generated.  As people chase that “stuff” by offering more money for it from the abundant supply of that cash,  you benefit. And no, Justin, printing more money to help the poor won’t solve the problem. It adds to their problem in the long run. Economics 101, baby.

Do yourself a favor

I began warning you in late 2021, then pounding the table on at the beginning of this year about a bear market. I warned you about inflation “stickiness” in 2020, a probable recession early this year – both times when others were less concerned.  ValueTrend was prepared, and our  managed clients have been profiting by this volatile environment.

Were you as well prepared?

If you feel your portfolio management strategy is not as well-managed as you’d like – contact us. We’ll explain how we can manage your money as prudently and conservatively as we do for all of our ValueTrend clients. Contact us here.