Taps Coogan – May 17th, 2022

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As I listen to and survey the various people that I respect, I keep hearing iterations of the following outlook: we may see a bond/stock rally from these levels but the bear market isn’t over and we are pointed towards a recession, though probably not until next year.

The logic of that view is robust. P/Es are still high, inflation seems sticky, recessionary conditions aren’t immediate enough to halt the Fed tightening cycle, and therefore there is room for further downward pressure – punctuated by bear market rallies – before we eventually reach a recession next year.

That ‘consensus’ view, if we can call it that, seems like a reasonable base case, but given how widespread that view seems to be, it’s worth considering a not-all-that-outlandish contrarian case, especially because buying some optionality on that contrarian view is getting pretty cheap.

That contrarian view might look like this:

We are going to have a serious recession scare in the next couple months, not next year, and the Fed tightening cycle is going to be meaningfully less aggressive than what is currently expected.

Why pull forward the recession scare? People seem to be grossly overestimating the ability of the US economy to absorb radically higher borrowing costs at a time of tightening liquidity, record debt, and still massive deficits (both trade and budget).

What’s the implication of all that? The rally everyone is expecting may not manifest until the Fed blinks, which may be sooner than anticipated, but not now. When they do blink, it may be be bearish for the dollar and eventually bullish for some growth and non-US stocks. Those bets may be wrong, but some of them are getting pretty cheap.

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