The Next Big Letdown for Stocks.

Walls Street is hoping for rate cuts and a new bout of QE, expecting that a recession will force the Fed’s hand. Stocks have surged for three months based on that hope for a recession, rate cuts, and QE. But what if the Fed stopped tightening too soon, and instead of a recession, we’ll get slightly lower economic growth, but with some added inflation? (10 minutes)

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  50 comments for “THE WOLF STREET REPORT

  1. Auld Kodjer says:

    Navigating a mild recession is like tiptoeing through a minefield, with the UXO numbers continuing to increase with every delay. Meanwhile the FED holds a very old and smudged map without any indication of true north.

    • Jack says:

      Actually the Fed’s got the latest edition of the map , it’s only choosing to go by the same principles that holds the helicopter propeller to the vertical shaft!

      You know which one I mean?

      “ the Jesus Nut”!! :)

    • nick kelly says:

      ‘Last week’s partial yield curve inversion following a “dovish surprise” from the Federal Reserve is bearish for the stock market…’ Morgan Stanley

      Message for the Fed: ignore the stock market who you can’t please anyway and do your job of normalizing rates. Having been through several years of a good recovery it is obvious the Fed should have stored up more dry powder by now. But every time Wall Street gets a paper cut it calls the Fed for an ambulance. That’s normal. What isn’t normal is for the Fed to send one.

  2. WES says:

    Looking around the world, the US economy remains the only bright spot.

    China, Europe, Canada all appear to be heading or are in a recession.

    If the US only suffers a slowdown then it can only due to better management of their economy.

    If a recession hits Canada, as it appears to be, it will be due to the cumulative compounding of Trudope’s very anti- business policies.

    • Lance Manly says:

      >If the US only suffers a slowdown then it can only due to better management of their economy.

      A massive debt driven fiscal stimulus does not hurt the economy, party now pay later. BTW: Like it or not globalization is a fact of life. The slowdown in Europe and Asia will be a headwind for US growth going forward. And for stocks it will hurt profits for overseas operations. Morgan Stanley is already calling for an “earnings recession” for the S&P, that won’t help Shiller PEs.

      • Anon says:

        Globalization was a fact of life. Now de-globalization is happening to some extent. US pressed for an open-door-policy for China at one time before the establishment of the Chinese Communist Party. Now China is complaining that the equivalent open-door-policy for the US established after WW2 is being partially closed. Irony or foreshadowing?

        • Rcohn says:

          Repeat after me
          China is the enemy
          China is the economic enemy.
          China is the military enemy
          Obama’s policy of benign neglect in hopes that China would ameliorate its policies will go down as one of the worst foreign policy decisions in history

  3. Howard Fritz says:

    Honest question a friend of mine rents a few homes he told that even though the home itself has “doubled” in the past five years however he can’t raise the rent at all.

    Surely these types of gains are a result of paper wealth and demand upon finding a sucker willing to pay the inflated asset prices with dreams of selling to another sucker.

    Normally someone has to hold the bag eventually however those affirmative asset holders apparently believe this can go on forever?

    • Ken says:

      Either it’s a bubble and housing prices correct or it’s inflation and it leads increasing rent costs.

      • JZ says:

        Absolutely agree. Paul T Jones said “I always bilieve prices move first and then fundamental(rent, earnings, dividends) will catch up”.
        If the fundamentals do catch up, you successfully front run everybody else.
        If the fundamental do NOT catch up, you are the sucker/bag holder.
        Above is basically saying “efficient market” is “USUALLY” true, but NOT “ALWAYS”.
        I have no opinion on whether “they” will shower everybody will “universal income”, “helicopter money for the people”, or massive infrastructure buildup to hire everybody and wage inflation goes north of 5% per year.
        What I do think is that “fundamental” is up to Washington’s, while “price” is up to FED.

        • JZ says:

          Both FED-price and Washington-Findamental are “fake” price and fundamental. Both are adrainaline shots that will boost for “incumbent” FED chair and POTUS and creating hang overs for the next. Zombify and druggy-convert the entire economy and its population. Corruption, corruption, corruption.

    • SaltyGolden says:

      That (irrational relationship between prices and rents) has to be a pretty strong signal that things have gone awry.

      • d says:

        Wages must go up over 100% or property prices must come down by around 50%, very soon, if not, long term, something big MUST Break.

    • Matt P says:

      Probably a good time to sell.

    • alex in san jose AKA digital Detroit says:

      Real incomes are going down while homelessness is going up. Conclude from that what you will.

      • Max Power says:

        I don’t know where you are getting your data from but real incomes are not going down.

        That said they are not rising that much either.

        • Michele says:

          According to a Nerdwallet article from last December ( median household income was up 22.16% in the ten years between 2008-2018. If you look at their chart you’ll notice that housing is up 18.91% in the same timeframe, but medical costs are up 32.69% and, interestingly food eaten away from home is up 27.45%….so beware the avocado toast special.

      • Setarcos says:

        Wage growth has been very strong. With unemployment at 1/2 century lows, wages will continue to increase. Even millions of illegals working can’t keep a lid on wages when labor is this tight.

        With that said, the 3 month inversion to the 10 year has historically signaled a recession 1 year out.

    • Paulo says:

      It has always been my belief about rentals is that if you own the place outright, rent received above and beyond the associated operating costs of maint and taxes is basically ‘found money’. If you bought at the right time of cycle the property always holds or increases in value. (Notice the phrase…right time……and that isn’t now, at the lemming peak). If you don’t own the place outright then the above associated costs have to include the price of financing the mortgage. Those ‘all in’ costs determine whether or not the current property price is too high. This is different than buying a home for personal residency.

      It helps if you have the skills to actually maintain the property and everything is more than a paper exercise. If you have to be a landlord to make a living, have fun. I would hate it. We have a local bandit who seems to enjoy fighting with his tenants. He pulls rank and is often just abusive towards them. While he has been away this winter (in mexico) a very nice couple he rents to have both contracted terminal cancers. Now, they are really at his mercy. Most of us in the neighbourhood are silently rooting they quit paying their rent. We’ll see.

      You want to be a landlord? What would you do if your tenant faces misfortune….job loss or a disease?

      • Gian says:

        Without landlords there would be no renters and the homeless ranks would swell exponentially. Not all landlords are bad and not all renters are bad. I own (outright) 7 rental properties and while I treat my renters with respect, it is a business transaction. My renters have been in my properties for an average of 8 years and appreciate the fact I have never raised rents and have a maintenance crew that responds to all repair requests forthwith. You are deranged if you believe tenants should be permitted to squat in their landlord’s house. Try that with your mortgage company (if you own) and see what compassion your banker has. Under your theory of what is equitable, your employer gets cancer and withholds your pay for several months. Are you willing to be as compassionate in this instance too?

    • Max Power says:

      This behavior is not that unusual.

      If you project a graph of changes in rent against changes in housing values you’ll see that it’s fairly common for housing values to swing quite a bit over the course of several years while rent tends to stay on a very stable slope.

    • Nick says:

      are you describing Australia?

  4. Trinacria says:

    without corresponding cuts in government (of course, will never happen) , also start to encourage and give folks and incentive to save again and reduce debt we are driving faster than Thelma and Louise toward that cliff…

  5. Bobber says:

    I’m not sure a recession, reduced interest rates, and QE would bring the stock market higher this time. Stock market valuations are a lot higher now than they were last time QE was implemented. Everything has a limit.

    Plus, think what would happen to pension funding if interest rates were repressed for another couple years. We already see significant underfunding along with a 6-7% return assumption. The side effects of QE aren’t some hypothetical anymore.

    • Rcohn says:

      Pensions obligations will be taken over ( in full) under the next Democratic administration.
      Remember deficits do not matter under MMT.

  6. SocalJim says:

    I have been beating the slower growth with inflation drums for quite a while. There is no other choice. Too much debt in the system.

    If the market decides the fed will tolerate some inflation without jacking rates up, stocks could move up.

    • Bobber says:

      In that inflation scenario, long rates would sky rocket, but the Fed has no control over them. Stock market disaster would quickly follow.

      • SocalJim says:

        If the Fed does not raise rates much during small to moderate inflation, the stock market would move up since stocks are an inflation hedge when inflation is not too high and the threat of rate increases is benign.

        • JZ says:

          Until inflation(CPI, PCE or what ever the “consensus”) reaches “4%”. That is the line in the sand.

          I agree with you on this one except I have always thought that one can NOT get into stag-flation (low growth, high inflation) without going to either “low growth, low flation” or “high growth, high flation” first.
          US has been in the “mild growth, mild flation” for a long time due to the FED meddling.

        • Bobber says:

          History says there is little to no correlation between inflation and stock prices. That’s because when inflation rises, interest rates also rise and that puts a big damper on stock prices.

          My own belief is the Fed can’t create inflation even if it wanted to, unless it alters the QE mechanism and gets money to the people who will spend it, rather than banks (i.e., a helicopter drop). The inflation we’ve seen has been attributable to fiscal policy (i.e., tax cuts), not QE. The last time the Fed did QE, the banks just sat on the money. In fact, QE didn’t create an inflation in Europe or Japan either. All it did was prop asset prices.

          The only way to create inflation that goes beyond asset prices is a helicopter drop, and that would of course be disastrous. Who in their right mind would believe the government would stop the helicopter drop after doing it once? It would create hyperinflation.

          I guess they could create inflation through more fiscal stimulus, but I think that well has been tapped with the federal debt at $22T, although I recognize they are trying hard to justify larger deficits via the MMT bull.

  7. NotEveryBondBidIsForQE says:

    Stock market bulls are always in lala land…very few global markets seem like there is some strength that isn’t from temporary liquidity injections by a CB.

    I don’t bonds aren’t only being bid because investors are expecting more QE and more rate hikes: They’re also being bid by (ex-US) investors (especially on the long end) because of the recessionary environment in Europe and a few EM’s who don’t have access to parking reserves at the fed for the risk free rate at 2.5. They’ll be out again when they can find something that can yield something worth the risk, but the 1year and the 10year inverted so I do not think it will be this year.

    However this isn’t good for stocks as well. On top of this, I still think we’ll see a credit event in 2019 (2018q4 freeze was just a brief taste), and my hunch is that regional banks might be a trigger (Fed exceptions for stress tests in 2019, rush of a bunch of mergers, nearly gave back all its 2019 gains already), the coiling up in the HY corporate market does not seem bullish and that’s already down from its highs (cumulative par values) in 2017 since the recession, and bid-ask spreads are still liquidity risk regime change from sept.

  8. ZeroBrain says:

    It was mentioned that financial services and insurance had 8% growth and that that will buoy the economy. These are non-goods-producing sectors that produce (IMO) little or no tangible value. Financial services and insurance can only facilitate investment in other value-producing sectors, but those value-producing services are already measured separately. Thus, GDP will get a boost from what I consider double-counting, but it won’t relate much to the “health of the economy” or whether the economy works for Americans.

  9. Rob says:

    If the economy is growing and wages trend up then we start transitioning into a wage/ inflation/ investment led cycle as opposed to a credit/ financial asset led cycle.

    As such the next Fed move is probably a rate hike, the question is when the market focussed on that.

    In the short term if Q2 bring contracting Manuf PMIs the market could price in a rate cut first before then having to do a 180 degree about face later in the year.

  10. Anon says:

    Apparently Congress has decided the US is going to transition into an economy that provides social services to unskilled immigrants. Anyone see how this is going to function long term? I expect the immigrants to get disillusioned and head back home. Government handouts always come with unpleasant side effects. Negative for equities since Federal Government becoming more if not most of the economy. US turning into China? (eg command economy saddled with debt that isn’t going to be repaid)

    • Chris says:

      The reason for illegal immigration is the broken immigration system. If we had this system in the 20th century, anyone who migrated from Europe would have been an illegal immigrant. Fix the immigration system and make it fair and there would be no illegal immigration.

      • Anon says:

        I said unskilled immigrants. At this time the US seems less prepared to successfully handle unskilled immigrants than any other time in its history. Social services are more comprehensive and costly and centralization has crushed local innovations. Follow federal regulation to the nth degree or get sued.

        • Paulo says:

          I just read an Anthony Bourdain book, Kitchen Condidential. One nugget was his explaining the role of ‘illegal immigrants’ in all (ALL) of the Country’s finest restaurants. He said they would not be able to operate without them; they keep their heads down, work very very hard, and go on to find success and become legitimate. They buy homes and stay. “Give me my Guatemalens”, he said. “I’ll take a Central American over a gringo any day”.

          Add to that the labourers on jobsites, roofing crews, etc you see the trends. Plus, all the so called skilled occupations are learnable. It’s not like the instructions to become anything in life is written in Martian, available to just those with the right piece of paper. The illegal system works and exists for a reason. It holds down wages and increases inequality, just the way the rich like it. Plus, it comes with a ready made scapegoat to divert attention from what is really going on.

      • Unamused says:

        =>The reason for illegal immigration is the broken immigration system.

        Businesses want cheap immigrant labor. Everybody from Iowa farmers to the POTUS has actively recruited illegal immigrants.

        At the same time, immigrants are to be scapegoated for the abuse of US workers by businesses, again, everybody from Iowa farmers to the POTUS.

        The immigration system is broken because businesses want it both ways. The bad news is that it works, so the immigration system will stay broken. Reforms to the US immigration system have been successfully sabotaged for decades to produce exactly this result.

        So you see, this condition is motivated and maintained by perverse financial incentives. You can find PFIs everywhere:

        – Corporatists want a recession so interest rates will fall, enabling scams based on cheap credit.
        – Corporatists want increased unemployment so workers will settle for lower pay.
        – Doctors avoid proper treatment to enable resort to profitable procedures.

        Just about anybody can come up with a list of dozens of PFIs without any effort. For example, it’s obvious that dishonesty of every kind is highly motivated and has historically been a standard personal, political, and business strategy. Think tanks are devoted to identifying, cultivating, and exploiting PFIs. Cheaters win.

        The motivations for reason and self-preservation are hopelessly outclassed, out-manuevered, and out-gunned by perverse motivations. If you study these issues seriously and add up all the nastiest of such incentives, financial and otherwise, you will inevitably conclude that humanity is perversely and conclusively incentivised to ruin itself.

        “We’re not going to make it, are we?” John Connor asked. “People, I mean.”
        “It is in your nature to destroy yourselves,” said The Machine.

        I’m going to miss you guys.

        • Wisdom Seeker says:

          Unamused, what’s this about “I’m going to miss you guys.”


          Are you leaving us? Or was that just tongue-in-cheek about humanity destroying itself?

          P.S. Fortunately the economists are wrong about human motivation; greed is not the sole driver. The perverse incentives are balanced by general human decency, the declining marginal utility of income, and the tendency of the PFI-exploiters to squander their advantage by fighting one another. PFIs have been with humanity since before there was history, and yet here we are. So I see reasons for concern and for action but not for despair.

        • Rcohn says:

          A true cynic

  11. The U.S. stock market will “magically” collapse in September, October and November of 2020 all but assuring Trump is soundly defeated in the 2020 election. This is the ace in the hole to get Trump out of office once and for all. Trump already knows this but is powerless to do anything about it. This is what Trump gets for rigging the stock market to highs 50 to 75 years in the future. Trump’s fake stock market is going to be his linchpin.

    • Nicko2 says:

      Conspiracy theories aside, there are a litany of reasons for Trump to go….and if a recession is indeed immanent, far better for it to happen during his watch than the next incoming DEM administration.

    • Paulo says:


      You optimistic dreamer, you. :-)

    • cesqy says:

      If they want to, the Fed can keep the stock market inflated a lot longer than a rabid and ineffective opposition can make it fall.

    • Rcohn says:

      According to the bets that people are currently placing on the 2020 election, Trump has the best odds at .38, while Biden leads the Dems with .18 with Harris second at .10

  12. “Latest Inflation Expectations Model Release (March 12, 2019) The Federal Reserve Bank of Cleveland reports that its latest estimate of 10-year expected inflation is 1.73 percent. In other words, the public currently expects the inflation rate to be below 2 percent on average over the next decade.”
    Although the TIP is strong it tends to rally on low interest rates, because 1.7 is good when the ten year is below 2%. With high yield soldiering through expect energy to collapse. Problem is the market got what it wants (lower rates) but lower rates beget lower prices and deflation.. Fed raises rates, which increases inflation, Fed backs off, inflation drops. Did they quit too soon??

    • Anon says:

      Accidentally have it backwards? The theory is that raising rates decreases inflation. My belief is that all the subsidies and mandates have made the theories non-predictive at this time. (so I really don’t have a problem with what you said except in the theoretical sense.)

  13. Laughing Eagle says:

    Great report and insight, Wolf.

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