Searching for Silver Linings

Editor's note: Right before Thanksgiving, Altimetry Founder Joel Litman and Director of Research Rob Spivey teamed up to write one of our favorite essays in recent memory. We received great feedback from subscribers... So we're sharing an updated version as we wrap up the final week of the year.

Our offices are closed on Monday, January 2, for New Year's. Please look for your next edition of Altimetry Daily Authority on Tuesday, January 3.

In the meantime, here's one more reminder that despite a tough year in the markets, there's plenty to be thankful for heading into 2023...

'Jingle Bells' wasn't written with Christmas in mind...

Songwriter James Pierpont penned the tune, originally titled "The One Horse Open Sleigh," in the 1850s just outside of Boston. Today, it has become synonymous with the Christmas season.

So it might come as a surprise that Pierpont actually wrote it to celebrate Thanksgiving.

In the U.S., there has been a growing din over the past decade-plus to start the holiday season earlier. For a long time, Thanksgiving acted like a levee... holding back Christmas music until just before the calendar hit December.

Nowadays, it's quite common to see Christmas promos (and to hear Christmas songs) the moment Halloween ends. While that might seem premature to some folks, our team in the Philippines is way ahead of us. They have something called the "ber" season.

No, it's not the "brr" season. It's never cold enough in the Philippines to need more than a light coat. The "ber" season is when their Christmas celebration takes place.

Every month that ends with "ber" is part of their holiday season. So it doesn't start in December, November, or even October. It starts all the way back in September.

And that means everyone in the Shangri-La Plaza in Metro Manila's Ortigas Center has been hearing the song "Jingle Bells" for almost three months by the time Thanksgiving rolls around.

Of course, we get into the holiday spirit as much as the next guy. Still, there's something to be said for pausing at the busy end of the year... and reflecting on what has been dubbed the "forgotten holiday."

So in the spirit of giving Thanksgiving the attention it deserves – and as a nod to fellow Bostonian James Pierpont – we're looking for silver linings today.

It might not feel like investors have much to be thankful for this year...

Elevated inflation and high interest rates are stifling spending. Signs of a looming recession have everyone on edge.

In late October, a key recession indicator flashed. When the three-month/10-year Treasury spread inverts, it's a virtual guarantee that we'll get a recession in the next six to 24 months.

Don't abandon all hope. If we're looking for something to be thankful for, James Pierpont's nephew is a good place to start.

The aforementioned nephew was none other than John Pierpont (J.P.) Morgan. Yes, that's the same J.P. Morgan who helped turn the U.S. into the economic superpower it is today.

Morgan helped create the banking and credit system as we know it. He's best remembered for acting as the country's central bank in 1907, before the Federal Reserve existed. He even pushed for the founding of the Fed.

Regular readers know we often say that understanding credit is essential to understanding inflation... the economy... and recessions. And that's exactly where we see a silver lining today.

It looks like inflation is finally cresting now that the Fed has gotten serious about fighting it. This is similar to what we saw back in 1947, when the central bank's actions cooled inflation by more than two-thirds in a matter of months.

It's also similar to what former Fed Chairman Paul Volcker managed in the 1980s. He raised interest rates as high as 20% until inflation was back under control.

Today's interest-rate hikes are working. We're no longer staring down a decade of high inflation and weak economic growth, like we saw in the dreaded 1970s. That is certainly a silver lining.

We're also not headed for 'stagflation'...

The term refers to a period of huge unemployment and flat (if not negative) economic growth. We saw this situation during the "lost decade" of the 1970s.

Those who say stagflation is happening again simply haven't studied enough financial history.

Most people are dreading a repeat of 2008 – folks losing their homes, mass layoffs, a stock market crash, and credit markets shutting down.

That's not what we expect from this potential recession at all. The reality is that consumer credit is remarkably healthy today. Delinquency rates are still lower than they were before the Great Recession.

Similarly, corporations look like they'll be able to manage a credit contraction. They have a good amount of cash on hand. And they've staggered their credit maturities quite well.

In other words, companies may need to tighten their purse strings in the next year or two. That doesn't mean we'll get a massive wall of potential defaults that could lead to a crashing economy.

Heading into the 2008 recession, consumers were in a much worse position. And corporations and banks were stretching their balance sheets to the brink. That's why the recession was so deep... and why the stock market crashed so hard.

Consumers and corporations are far healthier heading into whatever recession is in the works today...

We believe a more realistic scenario is a mild recession that looks like what we saw from 1948 to 1949. Similar to back then, extreme demand is driving inflation... the Fed is trying to slow that demand down... and balance sheets remain pretty healthy heading into tough times.

Said another way, this downturn is more about the Fed trying to slow spending and lessen demand than it is about borrowers behaving badly.

That means we can expect a sideways equity market for the next two years. While it's not ideal, it's far better than stocks tumbling due to greater economic pain.

As recessions go, that's a silver lining to be grateful for.

Importantly, it also means that some industries still have a ton of upside. There's still plenty of demand for investment in supply chains. And a mild recession won't throw off the U.S.'s position in the global economy. We'll still keep our dominant spot on the world stage.

There's no denying that it's a scary time to be an investor. Doom-and-gloom headlines from the mainstream financial media aren't making things any better. That being said, it's also an exciting time... if you know where to look.

And that brings us to one of the things we at Altimetry are most thankful for – our ability to reach out to you, our customers and clients, about the state of the markets. It's a privilege to guide each and every one of you through this turbulent time.

We wish each of you a happy and joyous New Year.

With love, joy, peace, and thankfulness,

Joel Litman and Rob Spivey
December 30, 2022