The Balloons Are All Falling: What Some of the Great Voices Predict for 2023 and Beyond

Not all these voices are “great” as in “wise,” but some are that, too. What follows are some of the words from a couple of big economic thinkers who have predicted big crashes in the past and one major establishment voice who, all of last year, has been contradicting the predictions of his big colleagues.

Let’s start with Larry Summers

Why start there? Because I like our snarl-faced former US Treasurer under Bill Clinton the least by far, but he’s been a real contrarian of late compared to his many counterparts. You’d almost think he’s gotten some anti-establishment religion. And he’s been right about where and how the economy was going down throughout the past year. I’ve not found much to disagree with him on for almost a year, and that’s unheard of in my experience with this guy over my past decade and a half of writing this blog.

Summers Sees Signals of a Sharp Drop-Off in Economic Activity

… “We’ve got an extremely difficult economy to read,” Summers said on Bloomberg Television’s Wall Street Week with David Westin. “People may be reading a bit too much into the moment in terms of economic strength — relative to the way things could look very differently in a quarter or two.”

But “there are a variety of leading indicators that are more troubling,” he said. Among the signs of concern:

• Inventories “look to be building up relative to sales.”
• Companies are “reporting concerns about their order books.”
• The business sector appears to have a high payroll head-count relative to “the level of output they’re producing.”
• “Consumer savings are being depleted, with a low savings rate.”
  

The former Treasury chief also reiterated the lack of past examples in which the US managed to avoid a recession when the unemployment rate dropped below 4% and inflation went above 4%. 

“That’s a powerful historical truth and I think it’s one that’s relevant to our current situation,” Summers said.

Bloomberg

Besides saying all of last year what I’ve also been saying for more than a year about inflation, Summers also spoke rather dramatically about a likely rapid change:

Top Economist Larry Summers says … there’s a risk the economy ‘hits a sudden stop’

“The Fed’s been trying to put the brakes on, and it doesn’t look like the brakes are getting much traction,” Summers told Bloomberg Television’s Wall Street Week with David Westin. “The risk is that we’re going to hit the brakes very, very hard.”

He flagged that there’s still a possibility the economy hits a sudden stop, when companies reckon with a build-up of inventories and headcount on their payrolls, and consumers deplete their savings.

…chances are the Fed will take longer to get to its peak policy rate — or that it will need to pick up the pace of hikes — he said.

“It raises the possibility that we’re not landing at a terminal rate sometime in the next several months — or that we’re going to have to go back to hitting the brakes harder by more than 25 basis points,” Summers said.

Fortune

In another article, mentioning an even longer-term perspective,

Former US Secretary of the Treasury Lawrence H. Summers argues that we are facing the most acute economic and financial challenges since the 2008 financial crisis. And … warns of “a unique, uncertain and turbulent decade to come.”

Project Syndicate

Next up, Jeremy Grantham

Sure, you could say Jeremy Grantham is permabull who is only right in predicting the past major downturns, as he has done, because he keeps saying the same thing. It almost seems like that because he has been bearish for so long, except that he is not. He cofounded GMO, a major financial firm that has made a lot of money by being bullish about the right stocks over the course of his lifetime — when and where there is money is to be made. He began his career as an economist at Royal Dutch Shell, and he’s one of the rare major economists I find I agree with almost every time I read him.

Grantham recently wrote the following about where the world (especially the US) is headed:

The first and easiest leg of the bursting of the bubble we called for a year ago is complete. The most speculative growth stocks that led the market on the way up have been crushed, and a large chunk of the total losses across markets that we expected to see a year ago have already occurred. Given the starting conditions of extraordinary speculative euphoria, this was all but certain. The negative surprises of last year, from war in Ukraine to the global inflation spike, were quite unnecessary to ensure a significant downturn.

Now things get more complicated. While the most extreme froth has been wiped off the market, valuations are still nowhere near their long-term averages. Further, in the past, they have usually overcorrected to below trend as fundamentals deteriorated. Such an outcome still remains highly likely, but given the complexities of an ever-changing world, investors should have far less certainty about the timing and extent of the next leg down from here.

GMO

Grantham notes that the bear could take a pause at present due to a number of short-term global factors, such as China’s reopening. He also notes major longterm difficulties that will take years to play through, but then, for the intermediate term, he leans back hard on the distortions that still need to be worked out of the market and on the certain impacts of a much longer inflation and Fed tightening to fight it:

The State of the Bubble: Things Get More Complicated

Well that was exciting! There have been far too many boring years in my 55-year career and 2022 was not one of them!…

Year-end reviews are generally ascribing these pretty serious losses to the combination of the war for Ukraine, described as unexpected, and the surge in inflation, also described as unexpected in its severity and persistence…. The key here is of course the word “unexpected.” The irony for me is that I expected just this kind of broad market decline without any such unexpected help….

But after a few spectacular bear market rallies we are now approaching the far less reliable and more complicated final phase. At this stage housing markets, which are always slower to react, have not fully rolled over yet … nor have corporate profits yet been severely hit. The length and depth of continued market decline from here depends on how precisely the deterioration from perfect conditions will play out.

…Many of us might agree that seldom have so many severely negative potentials been out and about. “Polycrisis” may well be the word of the year. Should any one of these factors get out of control it might cause a severe global recession.

…the bursting of the global housing bubble, which is only just beginning, is likely to have a more painful economic knock-on effect than the decline in equities is having….

Housing busts seem to take two or three times longer than for equities – from 2006 for example it took 6 years in the U.S. to reach a low – and housing is more directly plugged into the economy than equities through construction starts and associated expenditures. Housing is also much more important for the middle class, whose wealth is often mainly in housing, who use far greater leverage through established, traditional mortgages than they ever do in stocks, and who are these days sitting on large gains resulting from 40 years of falling mortgage rates pushing up housing prices. Many of them see their houses as a major store of value and the bedrock of their retirement plans, and to see that value start to melt away will make them very nervous….

So don’t mess with housing! But we have.

While housing may be the biggest obvious breakage that is just getting underway in terms of pricing now that stocks have taken their first year’s price plunge, Grantham is also concerned that, in his many decades in finance, he has never seen so many threatening clouds gathered around that are likely to bring negative surprises:

The long list of things that have gone wrong – that could interact and cause some component of the system to break under stress (perhaps an unexpected component) – makes for depressing reading. The complexities have multiplied, and the range of outcomes is much greater, perhaps even unprecedented in my experience. That having been said, the odds of a major U.S. market decline from here cannot be as high as they were last year. The pricking of the supreme overconfidence bubble is behind us, and stocks are now cheaper. But because of the sheer length of the list of important negatives, I believe continued economic and financial problems are likely. I believe they could easily turn out to be unexpectedly dire. I believe therefore that a continued market decline of at least substantial proportions, while not the near certainty it was a year ago, is much more likely than not.

Even his best-case scenario sounds dire:

My calculations of trendline value of the S&P 500, adjusted upwards for trendline growth and for expected inflation, is about 3200 by the end of 2023. I believe it is likely (3 to 1) to reach that trend and spend at least some time below it this year or next. Not the end of the world but compared to the Goldilocks pattern of the last 20 years, pretty brutal. And several other strategists now have similar numbers. To spell it out, 3200 would be a decline of just 16.7% for 2023 and with 4% inflation assumed for the year would total a 20% real decline for 2023 – or 40% real from the beginning of 2022. A modest overrun past 3200 would take this entire decline to, say, 45% to 50%, a little less bad than the usual decline of 50% or more from previous similarly extreme levels.

The real risk from here is in the unusually wide range of possibilities around this central point. I would suggest wide and asymmetric error bars around any such forecast. Regrettably there are more downside potentials than upside. In the worst case, if something does break and the world falls into a severe recession, the market could fall a stomach-turning 50% from here. At best there is likely to be at least a further modest decline, which by no means balances the risks. Even the direst case of a 50% decline from here would leave us at just under 2000 on the S&P….

Now for timing. There are some complicating factors that seem quite likely to drag this bear market out.

That scenario is exactly in line with the projections I put out at the very start of last year’s collapse for an S&P target range that seemed likely to me to find the bottom of a hard collapse by the end of a stock-market decline I said would likely take 2-3 years to fully play out:

Grantham says a major factor in the remaining decline of this bear market and of other things that may crash into each other will be the recession that is certainly ahead of us that will compound the present troubles, and he presents this chart of one advance indicator of recessions that hasn’t missed a stroke in, at least, fifty years (the inversion of 3-month Treasuries over the 10-year):

He also notes that huge savings and investment gains in the average person’s pocket from all the government’s Covid stimulus packages created a cushion that has buffered the damage from the Fed’s tightening so far, but that will all be fully drained, he thinks, in just a few more months.

Grantham sees the present economic collapse as one that will be on par with 1929, 1972, 2000, and the 2006 housing bubble. In all of those times, the market took a year or two to find its bottom … after the recession started.

And, for those permabulls snorting their own testosterone who believed all of last year a Fed pivot would save the day, he notes that, in the major crashes, the market’s worst part of its fall has happened after the Fed’s first rate cut and that the bottom of the market during that worst part of the crash didn’t arrive until almost a year or more after the Fed returned to cutting rates.

Then he humorously notes he’s uncomfortable to find himself in the odd position of so many market-makers agreeing with him:

About now I should confess that I am rather rattled as a contrarian by the enormous increase in pessimism and realism since my letters of a year ago and two years ago, with influential firms like Morgan Stanley and Goldman Sachs pointing to recession and lower earnings that do not yet seem to be in the price of stocks. Equally disturbing, it is said to be one of the most widely predicted recessions ever. It is all enough to make a god-fearing contrarian wake up in the night sweating.

Let’s finish with Nouriel Roubini

The Nobel Laureate nicknamed “Dr. Doom” is a good place to finish up to end on a positive. Not positive as in cheery, of course, but as in someone who is positively sure of where this economy will end up.

Unlike Larry Summers, with whom I frequently disagree, Roubini is someone I rarely find reason to disagree with, so it was no surprise to find I’m on the same page with him now, as I searched to see what he’s said in the past month. So, with his clarion track record for naming the biggest economic crashes before they happen, he’s a good voice to conclude with:

‘Dr. Doom’ Nouriel Roubini says stocks and bonds will suffer for years to come as inflation hovers close to 6%

High inflation is here to stay, and that means stocks and bonds will endure more pain for years to come, according to “Dr. Doom” economist Nouriel Roubini….

“If I’m right, then the average inflation rate is not going to be 2%, it’s going to be 6%. And the losses we saw last year in bonds and equities, it’s going to be more severe in the years to come,” the top economist said in an interview with CNN….

Roubini, who is known for his grim predictions for markets and the economy, has warned of a stagflationary debt crisis, which combines the worst aspects of 70s-style stagflation and the 2008 financial crisis. That’s because central bankers will be torn between raising interest rates to fight inflation, and lowering interest rates to alleviate debt burdens, he warned. That could cause prices to spiral out of control and … hit the economy with a major recession.

In that scenario, stocks could crash as much as 30%, Roubini said…. Morgan Stanley has warned that stocks have entered the “death zone” and could see a 26% crash in the coming months as inflation continues to ravage the market.

Business Insider

I think, by that, he means an additional 30% just as Morgan Stanley means with its 26%. Morgan Stanley, too, was spot on all of last year, though I have not paid much attention to them in years before last.

In his own article, Roubini writes,

Sleepwalking on Megathreat Mountain

What I have called megathreats others have called a “polycrisis” – which the Financial Times recently named its buzzword of the year. For her part, Kristalina Georgieva, managing director of the International Monetary Fund, speaks of a “confluence of calamities.” The world economy, she warned last year, is facing “perhaps its biggest test since the Second World War….”

This historical connection is all too fitting. Our current age of megathreats resembles the tragic 30-year period between 1914 and 1945 far more closely than it does the 75 years of relative peace, progress, and prosperity following World War II….

[WWI] was followed by a pandemic (of Spanish flu); the 1929 stock market crash; the Great Depression; trade and currency wars; inflation, hyperinflation, and deflation; financial crises and massive defaults; and unemployment rates above 20%. It was these crisis conditions that underpinned the rise of Fascism in Italy, Nazism in Germany, and militarism in Spain and Japan – culminating in WWII and the Holocaust….

But as dreadful as those 30 years were, today’s megathreats are in some ways even more ominous. After all, the interwar generation did not have to deal with climate change, AI threats to employment, or the implicit liabilities associated with societal aging….

Moreover, the world wars were largely conventional conflicts….

We are therefore facing not only the worst of the 1970s (repeated negative aggregate supply shocks), but also the worst of the 2007-08 period (dangerously high debt ratios) and the worst of the 1930s. A new “geopolitical depression” is increasing the likelihood of cold and hot wars that could all too easily overlap and spin out of control.

Nouriel Roubini on Project Syndicate

Cheery.

But not unrealistic.

Conclusion

Some pretty big voices, who have seen things the same way I saw them all of last year, remain in the same view I remain in. Not only does inflation certainly have more damage of its own to inflict on the entire global economy, but it will force the Fed to fight tighter and harder for longer, doing more damage by the Fed’s hand as the Fed inevitably drives us into recession that we’d likely be in anyway due to all the surrounding crises that are also pressing in on us — a red-hot war on European soil that is a clash between superpowers with all of war’s planned and unplanned surprises, a bi-polar global economic split having much chaos to work out, smaller nations now entering debt-default scenarios and larger nations having to manage very high debts under rapidly rising interest, sanctions limiting resources and products all over the world, an energy crisis that is not yet likely over, a plague that appears to be abating, but who knows for sure, the possible aftermath from vaccines and/or long Covid, and, in my apparently still solitary view, a labor market that is badly damaged and weakened in that it is unable to supply labor even to match up with past production levels.

On top of all that and other gathering clouds not mentioned, we are flying with our economic gauges badly busted, as many are now saying, whose voices I’ll lay out in one of my next regular articles for all readers. There is nothing like flying through an extreme storm with your instrument panel completely out, flying by dead reckoning through the closing twilight — even worse if you’re in a hyped-up, hot-air balloon that is now out of gas.

Nouriel Roubini, who predicted the 2008 financial crisis, has a new book, Megathreats: The Ten Trends that Imperil Our Future, and How to Survive Them.