Monday, June 25, 2018

Blackstone's Byron Wien: "No Recession in Sight"

Our best guess is market downturn in 2019 and recession in 2020.*
But more new highs first.
Mr. Wien seems a bit more optimistic.
*(since we first went public with this prognostication the Nasdaq hit another new all-time high, the S&P and Dow = not yet)

From Blackstone, June 22:

We believe that the current business cycle has at least several more years left to run. 
My colleague Joe Zidle, who joined the firm earlier this year from a career as a strategist for Richard Bernstein Advisors and Merrill Lynch, has launched a new market commentary series. His pieces, published several times per month, are quick, insightful takes on key market trends and observations.
Read his latest piece “This Capex Cycle Is Just Getting Started” and subscribe for future commentary here.
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This business expansion has gone on for nine years and most investors think we have to be near the end. In baseball parlance you hear talk that we are in the seventh or eighth inning; nobody seems to believe we are in the second or third. Jamie Dimon of J.P. Morgan has said at a conference we’re in the sixth, which got a lot of attention. Those who are cautious on the outlook talk about how corporate cash flows will be inadequate to service long-term debt obligations. They also raise macro issues like the large U.S. budget deficit, declining American competitiveness, worsening relationships with our trading partners, Middle East instability, a slowdown in Europe, difficult 2019 earnings comparisons and displacement of white collar employees by artificial intelligence.

We believe that the current business cycle has at least several more years left to run. The major signs that would herald the beginning of the next recession are not yet in place. Unemployment is low and likely to decline further; wages are rising, but not sharply; the Federal Reserve is tightening, but real interest rates are zero; inflation is moving higher slowly; the yield curve is not inverted; profits are increasing; and the leading indicators are still rising. Until some of these indicators change, the expansion is likely to continue.

Policy makers will try to keep the expansion continuing as long as possible. I believe that they recognize that if we get into a recession, we do not have the traditional tools to get out of it. The usual pattern for the U.S. economy when it is in recession is either for the Federal Reserve to lower interest rates from a high level to stimulate business activity or the Keynesian method of providing fiscal stimulus. At this point, even though we are presumably late in the cycle, interest rates (Federal funds) are still low and a year from now, even with continued rate increases every quarter, they are still likely to be less than 3%. Lowering them from there would not likely bring on a surge in the economy because the real rate of interest would only be a still low 1%, not much different from zero, where we are now. The two-year / ten-year spread is, however, tighter. In terms of fiscal spending, the Trump Tax Cut and Job Creation legislation is likely to increase the U.S. budget deficit from $700 billion to $1 trillion, making it about 5% of gross domestic product. This is the highest we have experienced in peacetime. A Republican Congress is unlikely to want to increase the budget deficit from the current level even if real economic growth slows back below 2%.

Our bullish thesis will likely be tested this summer. Mid-term election year stock market performance is notoriously bad. Historically, the market has corrected an average of -18.9% from peak to trough leading up to the election, based on data going back to 1962. But July in particular is typically the most painful month, as history shows it is the month when the market loses its gains, turning negative in the year to date column. Over the years there have been many theories attempting to explain the weakness seen around mid-term election, none particularly good, but still the pattern seems to persist. The summer months may be rough but we are optimistic for year end, and stick with our S&P 500® target of 3,000.

There are several more fundamental reasons for further short-term weakness. Any bull market is always vulnerable to a 10% correction, and even though we already had one in February, we did not do enough damage to investor optimism to create a foundation for the next important move higher. Now we are getting some deterioration in the fundamental economic background that may make investors somewhat more cautious. This probably started with the decision of the Trump administration to withdraw from the Iran nuclear agreement. The plan was imperfect, but it obligated Iran to cease its production of nuclear material for a decade, and our major allies who participated with us believed the country was generally in compliance. Our decision angered our partners, reinforced their view that the United States was increasingly insular and added to Middle East instability. While it brought Israel and Saudi Arabia closer together, it also enabled Iran to support various hostile conflicts in the Middle East in Gaza and Syria. The decision to move the American embassy in Israel from Tel Aviv to Jerusalem virtually eliminated the possibility of a two-state solution to the détente between the Palestinians and the Israelis and added to the uneasy political condition in the region. A two-state solution was probably a long shot anyway, because the Palestinian Authority was demanding a right of return and the Israeli settlements in the West Bank represented a logistical problem.

The sharp drop in the price of crude relieved some inflation pressure and contributed to the drop in Treasury yields. I believe, however, this move is temporary. Both Russia and Saudi Arabia need the revenue from higher oil prices and I expect the price to move higher over the next two years as demand exceeds current supply and the industry continues to underinvest in the development of new resources. Venezuela will be producing less, hydraulic fracking in the U.S. may be limited by a lack of pipelines and environmental considerations and Middle East instability may limit production from other countries in the region.

When President Trump cancelled the Singapore meeting, I still believed talks between the United States and North Korea would take place. Both parties had too much to lose if they did not meet. Kim Jong-un would be deprived of the prestige he would gain from bringing Donald Trump to Asia to negotiate and the President would lose the opportunity to create a non-nuclear Korean peninsula (although I think the Nobel Prize would elude him). The most favorable outcome possible would have been a suspension of further nuclear development by North Korea but continued maintenance of their present stockpile of nuclear material. Expecting to achieve more from the negotiations was not realistic. The talks on June 12 carried risk, and if they went badly, the financial markets would not have responded well. As it turned out, the outcome was weak on specifics, but Trump was able to return to the United States and say that the likelihood of war with North Korea had been eliminated – and that’s what everyone wanted to hear.
Recent data out of Europe indicates some softening of the major economies....MUCH MORE