The biggest debate on Wall Street right now is whether the US economy will tip into a
either this year or early next.
Leading banks are updating their outlooks at a rapid pace. Goldman Sachs analysts now believe there’s a 30% chance that a recession could occur in the next 12 months, up from 15% previously.
Morgan Stanley economists are also updating their outlook to a 35% chance, up from 20% previously.
For the founder and chief investment officer of hedge fund Crescat Capital, Kevin Smith there is little to debate.
“We believe the US economy is spiraling headlong into recession,” said Smith in a June 28 research note. “On a
basis, we think one has already begun due to today’s high inflation rate.”
This isn’t Smith’s first bold call. Last month, he said stock prices could potentially fall another 78% to settle at the low multiples of the last stagflationary era.
Since he made that call, both the S&P 500 and the NASDAQ have fallen by around 7% on the back of aggressive interest rate hikes from the
to combat surging inflation.
Smith’s calls may seem outlandish but he was right last year when he warned of an imminent sell-off in the S&P 500 in December.
And since the start of this year Smith’s funds have surged: his macro hedge fund returned 39.7% through May 31 while his long/short hedge fund returned 14%, according to the note.
Over the same time period, the S&P 500 declined by 20% and the NASDAQ dropped by 29%.
What gives Smith conviction on his recession call is that household demand is “poised to fall off a cliff.”
“This is the onset of a vicious stagflationary environment,” Smith said. “The unprecedented combination of excessive debt, the bursting of speculative asset bubbles, and the persistence of inflation due to structural supply imbalances makes the current economic and market environment truly precarious.”
He shared five concerning signs investors should be aware of.
1) Plummeting consumer demand
The consumer’s ability to spend is plummeting. Real wages are declining by almost 4% and savings relative to disposable income is at the lowest level in 14 years, Smith said.
The recent rise in interest rates is also impacting home owners. Data from Goldman Sachs shows that the median monthly payment for a 30-year mortgage is up 56% year-over-year, which could impact household spending and slow economic growth.
“All these factors combined are likely to cause real consumer spending to fall significantly,” Smith said.
2) The wealth effect
The recent decline in the stock market also impacts US household buying power, which limits further growth.
“US stocks have already lost $13 trillion in
since the downturn started,” Smith said. “That is already a greater capital loss than during the Global Financial Crisis and Covid Recession.”
3) Corporate profits will take a hit
Investors shouldn’t just be looking at consumers when it comes to signals on an impending recessionary environment.
Corporate profit margins are record levels but the inflationary environment is likely to compress those margins, Smith said.
“The recent strength of the dollar is also an important factor to consider,” Smith said. “History shows that as the US currency appreciates relative to its peers, significant declines in corporate profits tend to follow.”
In a June 27 report, analysts at Goldman Sachs said that profit margins for the median S&P 500 company will likely decline next year whether or not the economy falls into recession.
4) Unemployment set to rise
One of the reasons some major investors and strategists have been reluctant to say the US economy is heading into recession is because unemployment remains low.
Peter Mallouk is the president and CEO of Creative Planning, a wealth manager that oversees over $225 billion, told Insider that exceptionally low unemployment is one reason he doesn’t believe the US economy will be tipped into a recession.
However, Smith believes that as corporate earnings decline, the labor market will soon struggle.
“Note that initial jobless claims have already been increasing since March,” Smith said. “Labor markets are a critical piece of the macro puzzle. If employment activity slowdowns from here, the Fed will be in a policy predicament.”
is one of the largest parts of the US economy, Smith expects that a further decline in stock price could impact the employment plans for many of these companies.
5) Tighter financial conditions
The US 30-year yield has broken from a 41-year macro downtrend, which concerns Smith because of the US economy’s existing “deep deficit.”
Smith believes US policy makers will need to impose yield curve control to avoid a sovereign default, which could prove risky in this high inflationary environment.
How to position?
Smith is confident that this sets the stage for a bullish environment for hard-money-based assets.
1) Precious metals miners
The supply of raw materials is still constrained and long-term capital spending on natural resources is near historical lows, Smith said.
“CAPEX trends take a long time to reverse, and this issue should continue to fuel commodity prices to increase over time,” Smith said. Precious metals and precious metals miners is one way to capture this trend.
“However, government spending will likely be increasing with inflation rates already historically elevated so nominal GDP may also be rising,” Smith said. “Ultimately, this combination should prove very positive for tangible assets, particularly gold.”
Copper recently entered a bear market falling over 20% from its peak in May, 2021. This is often seen as a signal for a recession as it’s happened before each recession in the last 30 years.
Copper’s recent fall confirms Smith’s recessionary thesis, but he also sees it as a buying opportunity.
“New government stimulus programs to bring us out of the recession and facilitate the energy transition should be highly favorable to copper in the years ahead,” Smith said.