So let me start with you David. The most basic question how bad is it
going to get. How bad is it going to get.
Well thank goodness it's Friday. The weekend should be a reprieve.
Tough day. Tough week.
Tough year. The S&P 500 is down 25 26 percent from
its all time high. This is this is a bear market.
I find myself thinking about the 1970s lately.
And I think something to keep in mind is that the 1982 bear market when the Fed
was fighting inflation aggressively back then the S&P fell 27 28 percent but in
1974 the S&P fell 48 percent. So I think a key question is is this the
beginning of a high inflationary period. Where are we near the end of a high
inflationary period. If you think we're near the end of a
high inflationary period the worst is largely behind and the market shouldn't
go too much further down. But that's the key question.
I'm not feeling much better. What do you think.
All right. I'm going to try to make you feel a
little bit good. So look we think that the market is set
to stage a major major battle at the 30 500 level.
And the reason for that is if you look back over the course of recessions into
the 30s a median recessionary draw down is about 27 percent.
And so we'll get there when we're around thirty five hundred on the S&P.
And I still as I talk to investors I think many are still in the mild kind of
quick or shallow camp. But do think there's going to be a
sluggish growth backdrop. Afterwards I think people are not really
looking for anything major like what we had in the financial crisis.
So I think that at least we've got that at our back.
I will tell you if you think about kind of where investors heads are at
something else that makes me feel a little bit better is I'm not sensing a
ton of panic definitely alarm. But the big question of the day is what
do higher rates for longer mean for valuation multiples.
And that's a very constructive conversation.
And we've done some work suggesting that we're probably getting pretty close.
If he hit that 30 500 level on the S&P to the same kind of multiple contraction
you saw back in the 70s over the course of the entire decade.
I want to come back to earnings. But before that we just heard from Lori
short and shallow. I think you said I think she's referring
to a recession. You're projecting recession.
And I guess my question really is normally if you have a recession we turn
our heads and look at the Fed and say OK please cut rates.
Do we have much room to really deal the recession.
If and when it comes we're expecting a short and shallow recession but we're a
bit concerned that the troughs might linger well into 2023.
We're not expecting a V shaped recovery after the small recession.
We think it can be slow real growth afterward.
The trouble here is that the Fed can't rescue us because of the inflation
problem and they can't attempt to rescue the equity market or even the economy
broadly until they're confident that the inflation battle's been won.
So I think what you people know it's pretty clear at this stage the Fed is
committed to fighting inflation and they've decided they're willing to risk
a small moderate recession tolerate one to make sure that this inflation boost
is slowing. So if we're talking about equities just
for a moment you've got at least two things going on.
One is valuations. And what we're expecting in the higher
discount rate affects that. Also earnings earnings.
What are you expecting on earnings at this stage.
We're expecting earnings for 2022 to be two hundred twenty five dollars.
I think at this stage you should not expect any growth.
It should be flat in 2023. But every day that goes by with the
shocks that we're experiencing higher interest rates the super strong dollar
collapses and other currencies around the world even oil prices have come down
a lot. And we are beginning to see a lot of
companies come out and say things are slowing.
So the earnings risk is mounting. What about earnings.
When we saw FedEx we saw Apple. We've seen a lot of earnings warnings
out now. So we're actually pretty far below
consensus where it to 18 for this year versus to eleven last year.
And then we're actually at 212 for next year on S&P earnings.
So we think this is going to be pretty similar to 2015 2016 where earnings
basically go nowhere for a couple of years.
And I do think companies are much more resilient in terms of managing their
business models than they have been in the past.
There's a lot more flexibility a lot more ways to suck out costs a lot of
more ways to manage through supply chains are improving.
But one thing we've been telling investors is as inflation moderates.
That takes a bite out of earnings because it takes a bite out of revenues.
So that's a big headwind. We've got next year.
So Lori can companies maybe resilient consumers how resilient are they.
And particularly tie that into unemployment.
Because if we do go this direction what kind of unemployment are we facing.
So look I think consumers are headed into some headwinds here and we're
starting to see trade down impact. You're seeing a lot of those references
on their earnings calls. We're also starting to see a lot of
impacts among lower end consumers higher and has been holding them much better.
But we do think the consumer is going to take some knocks.
One of the things that gives me comfort is when I talked to my bank analyst for
example they told me the starting points on various credit metrics are looking
much better than they have heading into past recessions.
So we think a lot of the consumer trends are going to head in the wrong direction
but they're not going to necessarily be hit as bad as they have in past
downturns. Just because balance sheets have been
cleaned up pretty strongly over the past few years then we're thinking similarly
that the consumer is having a tough time that got hit by this high inflation.
They see the high. Rates affecting the housing market but
this small recession should be marked by still an inflationary environment not
deflation and we think the labor market will be relatively OK.
They will suffer some knocks but we don't think unemployment goes up any
more than 1 percent. We're usually goes up 3 4 or 5 percent
during a recession. So if it's still inflation not deflation
and the labor market holds in there largely because supply is tight then
credit conditions credit costs. They should be benign.
That should help the banks get through this very well and that should help
investors in investing credit. 2023 should be a better year for fixed
income investing. So relatively benign.
What we saw in the United Kingdom this week was not benign.
There was a real break in the market dislocation.
Do we have to anticipate something similar that the United States.
The short answer is no. However what's happening in the UK is a
shot across our bough one that I hope our policymakers take very seriously.
And that comes down to when you're fighting inflation and your economy is
suffering supply side shocks and other pressures.
It is difficult to support the economy with monetary policy.
They're hiking rates the BSE and it's difficult to support the economy with
fiscal policy. They also have deficits.
So the United States needs to be a lot more mindful about its deficits whether
it's tax cuts or spending. These deficits need to be watched in
this time of rising interest rates. So Larry one more attempt to put this.
Our broader perspective on a great financial crisis is what we're all
afraid of. Right.
We're in better shape going in to this whatever this is than we were that time
right. I think we are.
I mean we again go back to our banks analysts who spend time scrutinizing the
balance sheets of the big major banks. And we think the plumbing is in much
much better shape. I mean the way I put it is the stress
tests do appear to have worked. That's one of the reasons why banks
haven't really been able to grow in recent years.
But it is also one thing that I think is going to really be an asset to the
financial markets in coming years. And we're overweight the banks we've
been adding this week. But on the banks specifically that's
great. And the banks which is up to all the
right regulation. What about the part that's not subject
to recovery. What about the the shadow banks.
What about the private credit issues. We don't necessarily know what's going
on there. Well there's some debt in the system
because debt was so cheap and readily available for the past 10 20 years.
But the banks just as Laurie said were confident that their balance sheets are
strong. Higher interest rates they should make
higher net interest margins provided their credit costs don't surge.
But a resilient labor market. Home prices may come down a little bit
but as long as they don't collapse people keep paying their mortgages
particularly they're locked in the low rates from before.