In 1999, I began saying the tech bubble would eventually spark a recession. Timing was unclear because stock bubbles can blow way later than we can imagine.
Then the yield curve inverted, and I said recession was certain. I was early in that call, but it happened.
In late 2006, I began warning about the subprime crisis. The yield curve again inverted, which warranted another recession call. Again, I was early, but you see the pattern.
Now let’s fast-forward to today.
The Business Cycle Is Broken
Peter [Boockvar] made an extraordinarily cogent comment that I’m going to use from now on: “We no longer have business cycles, we have credit cycles.”
For those who don’t know Peter, he is the CIO of Bleakley Advisory Group and editor of the excellent Boock Report. Let’s cut that small but meaty sound bite into pieces.
What do we mean by “business cycle,” exactly?
Well, a growing economy peaks, contracts to a trough (what we call “recession”), recovers to enter prosperity, and hits a higher peak. Then the process repeats. The economy is always in either expansion or contraction.
This pattern broke down in the last decade.
We had an especially painful contraction followed by a weak expansion. GDP growth should reach 5% in the recovery and prosperity phases, not the 2% we have seen.
The Credit Cycle Drives the Economy Today
Peter blames the Federal Reserve’s artificially low interest rates.
Here’s how he put it in an April 18 letter to his subscribers.
To me, it is a very simple message being sent. We must understand that we no longer have economic cycles. We have credit cycles that ebb and flow with monetary policy. After all, when the Fed cuts rates to extremes, its only function is to encourage the rest of us to borrow a lot of money and we seem to have been very good at that. Thus, in reverse, when rates are being raised, when liquidity rolls away, it discourages us from taking on more debt. We don’t save enough.
This goes back farther than 2008. The Greenspan Fed pushed rates abnormally low in the late 1990s even though the then-booming economy needed no stimulus. That was in part to provide liquidity to a Y2K-wary public and partly in response to the 1998 market turmoil.
Bernanke was again generous to borrowers in the 2000s, contributing to the housing crisis and Great Recession. We’re now 20 years into training people (and businesses) that running up debt is fun and easy… and they’ve responded.
But over time, debt stops stimulating growth. Over this series, we will see that it takes more debt accumulation for every point of GDP growth, both in the US and elsewhere.
Hence, the flat-to-mild “recovery” years.
Debt-fueled growth is fun at first but simply pulls forward future spending, which we then miss. Now we’re entering the much more dangerous reversal phase in which the Fed tries to break the debt addiction.
We all know that never ends well.
So, Peter’s point is that a Fed-driven credit cycle now supersedes the traditional business cycle. Since debt drives so much GDP growth, its cost (i.e. interest rates) is the main variable defining where we are in the cycle.
The Fed controls that cost—or at least tries to—so we all obsess on Fed policy. And rightly so.
Among other effects, debt boosts asset prices. That’s why stocks and real estate have performed so well. But with rates now rising and the Fed unloading assets, those same prices are highly vulnerable.
An asset’s value is what someone will pay for it. If financing costs rise and buyers lack cash, the asset price must fall. And fall it will. The consensus at my New York dinner with top market thinkers was recession in the last half of 2019. Peter expects it sooner, in Q1 2019.
If that’s right, financial market fireworks aren’t far away.