‘I’m about as bearish as I’ve been since 2008,’ says Hedgeye’s Keith McCullough. He’s steering investors to cash, gold and other defensive plays.
His investment-research firm’s economic models turned bearish on stocks and bonds at the beginning of 2022. Prices have since tumbled, but McCullough is still bearish. He’s now steering investors to defensive positions primarily in cash, the U.S. dollar, gold and income-producing equities.
McCullough is preparing investors for the painful recession he expects for both Wall Street and Main Street in 2023. To anyone expecting the Fed to realize its rate increases have been excessive and rescue the markets, McCullough is blunt: “There’s no dovish pivot,” he says.
Even if the Fed were to relent, McCullough says the damage is done. “They’re far too late,” he says of the Fed. “Just like it was impossible for them to stop inflation, it’s impossible for them to stop the pending U.S. corporate profit recession or the mainline recession.”
In this recent interview, which has been edited for length and clarity, McCullough outlines his base case for the U.S. economy and the financial markets going into 2023, and advises investors to take shelter from a coming storm many of them have never seen.
‘The recessionary economic data keeps getting worse.’
MarketWatch: In a MarketWatch interview last April, you said “the Fed always screws up” and predicted a bear market for U.S. stocks in the summer. That happened. What do you expect now from the Fed — learn from its mistakes or make more?
McCullough: Recession today is what “transitory” inflation was a year ago. The Fed is as wrong on recession risk as they were on inflation.
I’m about as bearish as I’ve been since 2008. Instead of the economy having a soft landing, I think the landing is going to be hard. The recessionary economic data keeps getting worse, not just in the U.S. but in Europe as well.
Free money forever created behavioral problems and a behavioral bubble for the markets and investors. You believe you’ll have unlimited access to easy money and your behavior, whether you’re building profitless growth companies through storytelling or cryptocurrencies that also are just stories. You’re coming from the mother of all behavioral bubbles that now will be addressed with tighter money. When you’re printing money and the economy is accelerating to the fastest growth rate ever, you’re going to have the mother of all bubbles. Now, GDP is going to slow to zero, and you get the opposite.
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MarketWatch: A hard landing for the economy and an economic environment echoing the 2008 financial crisis is a pretty damning verdict. You’re not in the perma-bear camp with some forecasters, so what are you seeing now to have such a pessimistic outlook?
McCullough: On a lot of levels it’s worse now than in 2008. If 2008 was about Wall Street collapsing on itself, on all its conflicts of interests and lies, this one is more about Main Street. Main Street is broke. Main Street is taking all this inflation into their cost of living. Main Street has the highest credit-card interest going back to the 1990s. It’s way worse than 2008 on that basis. If you’re trying to pay your bills with credit, it’s getting worse and worse. And then they’re going to lose their jobs. Labor collapsing is always the last thing to go down. We’re right on the cusp of the labor cycle going the wrong way.
‘The big screw-up people will have is that the minute they see Fed dovishness, they’re going to buy stocks and crypto.’
That’s what’s going on right now. GDP and profit growth are both going negative. The Fed is going to see all of that and have to change. The big screw-up people will have is that the minute they see Fed dovishness, they’re going to buy stocks and crypto. Then they’re going to realize they’re in a recession, which is an entirely different setup from what got those bubbles to begin with, which was unlimited easing and fiscal support plus GDP growth.
We have economic deceleration irrespective of what the Fed does. It’s impossible for the Federal Reserve to stop gravity. They’re far too late. Just like it was impossible for them to stop inflation, it’s impossible for them to stop the pending U.S. corporate profit recession or the mainline recession.
MarketWatch: It isn’t just the Fed that could miss the recession signs until it’s too late. Stock investors as well might find themselves on the wrong side of the tracks.
McCullough: The Fed first has to realize that what I’m talking about is the high-probability event. That will take time. It’s not going to take them a month. They have to realize we’re in a recession, then make the commensurate policy pivot. Then, when the Fed does go dovish and realize we’re in a recession, that’s bad for the stock market.
The Pavlovian response is the Fed is dovish, buy stocks. That’s true if you’re not in a recession. This next recession — which could be the biggest profits recession of the modern era — will be quite an education for people who are still bullish, with the expectation that the Fed is going to save them.
MarketWatch: Many Fed-watchers and market analysts expect the Fed to pause or slow rate hikes to assess the effects of their inflation-fighting efforts. Do you see a “Powell pivot” coming?
McCullough: There’s no dovish pivot. The level of inflation is nowhere near the Fed’s target. And there’s a midterm election coming up. They’ve already established that the rate hikes are going to go right up to November. Rate hikes are baked into the cake and anybody looking for it to turn into a birthday cake for the bulls will be sadly disappointed.
‘The Federal Reserve, even if it were to turn dovish on interest rates tomorrow, will have a hard time stopping the profits recession.’
An entire generation of Americans hasn’t gone through a recession. A lot of companies in Silicon Valley have never been through a recession, for example. My definition of a U.S. corporate profits recession is when the rate of change of revenue growth has gone negative and the rate of change of year-over-year profit growth has gone negative. The Federal Reserve, even if it were to turn dovish on interest rates tomorrow, will have a hard time stopping the profits recession.
When the rate of economic change is accelerating and the Fed is printing money, you buy anything that’s got a good chart and a good story. You’re going to make a lot of money until the music stops.
And it did. Now we’re seeing the opposite. The rate of change of real GDP growth and inflation are slowing at the same time. You can’t own inflation, commodities or growth now. If you’re still long pretend growth or profitless growth or crypto, I recommend prayer.
MarketWatch: Given the grim picture you’ve drawn, where are you directing investors to put their money to weather the storm?
If you have to own stocks, we like quality balance sheets, profitable companies that have high-quality cash-flow streams. We’re short growth — all of it. We’re short all of tech. Energy stocks are levered up on the long side. I’ll take my time on that. It is a place I’m interested in buying, but currently we’re only long natural gas NG00, 1.51%, master limited partnerships, and solar through the Invesco Solar ETF TAN, -4.79%. We’re bearish on oil CL00, 1.41%, copper HG00, 0.50% — every major commodity other than natural gas. We’re short Europe on the equity side and on the euro EURUSD, -1.23%. I’m in no rush to cover those shorts. The trend is down for stocks and up for the U.S. dollar DXY, 1.21%.
Also Treasury bonds, but you have to wait, watch and act as the game plays out. If the U.S. 10-year Treasury BX:TMUBMUSD10Y breaks down below 2.95% that’s a pretty obvious green light to make long-term Treasurys one of your top asset allocations. A lot of people are trying to pick bottoms in stocks. I’m much more interested in buying Treasury bonds than anything else.