Summary
- Recessions are regime shifts that occur when fragile conditions meet a sufficient trigger. They differ greatly from a “normal” cycle, and are critical to identify in real time as the largest hit to risk assets always occurs at the beginning of recessions.
- An honest assessment of the first few weeks of the conflict in the Persian Gulf (reminder, we have no geopolitical edge) suggests this is likely to be an acute and protracted shock, with the likelihood of a global recession approaching a coin flip and steadily rising every day.
- Markets have started to price in a 2022 type scenario (tightening monetary policy amidst an energy shock) but are clearly underestimating recession risks. Cash (USD) will likely outperform all major assets over the next 1-3 months (aside from energy & food plays). Shorting energy importing regions (like Europe) is also attractive.
Recessions: the most important and least understood concept in finance
Our macro frameworks are centered around leading indicators (LEIs). These LEIs provide a longer lead (6-12 months) on risk assets and drive our main asset class views. However, a recession can be thought of as an “override” to these frameworks, which offer better context in the absence of recession.
It is critical to identify recessions in real time as the largest hit to risk assets tends to occur at the beginning of recessions.
However, while all recessions are different, they share a common structure.
Recessions are regime shifts. They are the product of accumulated fragility meeting a shock/trigger that traps both hard and soft economic data in a negative feedback loop. Once a key threshold is crossed, behaviors change and the state of the system flips rapidly.
This is why recession calls 12+ months out are not worth paying attention to. Recessions are fast-moving processes that look nothing like a normal cyclical slowdown.
That brings us to today.
The most common pushback against a potential recession appears to be: if there was really a serious risk of an energy crisis and recession, stock prices would be much lower.
The below chart looks at an assets current drawdown as a % of its median max drawdown
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