This stock market strategy says it could be the biggest recession ever. ‘I suggest a prayer.’

Keith McCullough, founder and CEO of Hedgeye Risk Management, is not bullish about the financial markets, the Federal Reserve or the economy.

Right now he has some less-than-charitable things to say about how stock and bond investors have been set up by the Fed’s rate hikes.

His investment-research firm’s economic models turned bearish on stocks and bonds at the start of 2022. Prices have been falling since then, but McCullough remains bearish. It is now directing investors to defensive positions primarily in cash, the US dollar, gold and ordinary income-producing shares.

McCullough is preparing investors for the painful recession he expects for Wall Street and Main Street in 2023. For anyone hoping the Fed realizes its rate hikes are excessive and has sent the markets save, McCullough is not blunt: “There is no dovish pivot,” he says. say.

Even if the Fed were to quit, McCullough says the damage has been done. “They are far too late,” he tells the feds. “Just as it was impossible for them to stop inflation, it is impossible for them to stop the pending US corporate profit recession or headline recession.”

In this recent interview, which has been edited for length and clarity, McCullough lays out his rationale for the US economy and financial markets heading into 2023, and advises investors to take shelter from a coming storm that may not many of them have ever seen.

‘The economic details of the recession keep getting worse.’

Market Watch: In an interview with MarketWatch last April, you said that “the Fed is coming apart” and predicted a bear market for US stocks over the summer. That’s what happened. What do you expect from the Fed now – learn from its mistakes or do more?

McCullough: Today’s recession is the “transient” inflation of 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 it’s going to be a hard landing. The economic details of the recession continue to worsen, not only in the US but also in Europe.

Free money forever created behavioral problems and a behavioral bubble for the markets and investors. You believe that you will have unlimited access to easy money and your behavior, whether you are building non-profit growth companies through storytelling or cryptocurrencies that are nothing but stories. You are coming from the mother of all behavioral bubbles which will now be faced with tighter money. When you are printing money and the economy is accelerating to the fastest growth rate ever, you have the mother of all bubbles. Now, the GDP will slow to zero, and you will get the opposite.

Read McCullough’s April 2022 interview: ‘The Fed is going crazy’: This forecaster sees US stocks in a bear market by summer

Market Watch: A hard landing for the economy and an economic environment echoing the financial crisis of 2008 is a pretty damning verdict. You are not in the perma-bear camp with some forecasters, so what are you seeing now that you are so pessimistic?

McCullough: On many levels it’s worse now than it was in 2008. If 2008 was about Wall Street collapsing, with all its conflicts of interest and lies, this one is more about Main Street. Main Street is broken. Main Street is factoring all of this inflation into their cost of living. High Street has the highest credit card interest rates dating back to the 1990s. It is much 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 are going to lose their jobs. Falling labor is always the last thing to go down. We are right on the edge of the labor cycle going the wrong way.

‘The big shock is that people will buy stocks and cryptos the moment they see the Fed horror.’

That’s what’s going on right now. Both GDP growth and profits are deteriorating. The Fed will look at all of that and it has to change. The main thing that people will do is that the moment they see Fed dovishness, they are going to buy stocks and crypto. Then they’ll realize they’re in a recession, which is completely different from the setup those bubbles first got, which was unlimited easing and fiscal support plus GDP growth.

We have an economic slowdown no matter what the Fed does. It is impossible for the Federal Reserve to stop gravity. They are far too late. Just as it was impossible for them to stop inflation, it is impossible for them to stop the pending US corporate profit recession or the mainline recession.

Market Watch: It’s not just the Fed that may miss the signs of the recession until it’s too late. Stock investors could also be on the wrong side of the tracks.

McCullough: The Fed must first understand that it is the high probability event that I am talking about. That will take time. It’s not going to take them a month. They need to understand that we are in an economic recession, then make the pivot of the policy equal. Then, when the Fed goes nuts and they realize we’re in a recession, that’s bad for the stock market.

The Pavlovian response is that the Fed is dovish, buy stocks. That’s true unless you’re in a recession. This next recession – which could be the biggest profit recession in the modern era – will be quite an education for those who are still bullish, hoping that the Fed will come to their rescue.

Market Watch: Many Fed watchers and market analysts expect the Fed to pause or slow rate hikes to assess the effects of its efforts to fight inflation. Do you see a “Powell pivot” coming?

McCullough: There is no dovish pivot. The inflation level is not close to the Fed’s target. And a mid-term election is coming up. They have already proven that the rate hikes will go up until November. Rate hikes are baked into the cake and anyone looking for it to make a birthday cake for the bulls will be disappointed.

‘Even if the Federal Reserve were to turn on interest rates tomorrow, it will be difficult to stop the decline in profits.’

An entire generation of Americans has not gone through the recession. Many companies in Silicon Valley have never been through a recession, for example. My definition of a recession in US corporate profits is when the rate of change in revenue growth has gone negative and the rate of change in year-over-year profit growth has plateaued. The Federal Reserve, even if it were to hike interest rates tomorrow, will have trouble stopping the profit slide.

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 are going to make a lot of money until the music stops.

And he did. Now we are seeing the opposite. The rate of change in real GDP growth and inflation is slowing at the same time. You can’t have inflation, commodities or growth now. If you are still pretending for a long time to grow or grow profitably or crypto, I suggest a prayer.

Keith McCullough

Hedge fence

Market Watch: Given the bleak picture you have drawn, where are you telling investors to put their money for the storm?

McCullough: There aren’t many places to hide. Our largest equity position is DJU utilities,
+3.19%.
A utility is a bond proxy. We still like GC00 gold,
+2.02%.

If you must own stocks, we like quality balance sheets, profitable companies with quality cash flow streams. We have short growth – all of it. We are all short on technology. Energy stocks are accelerated on the long side. I’ll take my time on that. It’s a place I’m interested in buying, but right now it’s only long NG00 natural gas,
-3.43%,
master limited partnerships, and solar through TAN Invesco Solar ETF,
+2.85%.
We are bearish on CL00 oil,
+4.78%,
copper HG00,
+0.09%
— all major commodities except natural gas. We are short of Europe on the equity side and the euro EURUSD,
+0.06%.
I’m in no rush to cover those shorts. The trend is down for stocks and up for the US dollar DXY,
-0.28%.

Also Treasury bonds, but you have to wait, watch and act as the game plays out. If the 10-year US Treasury BX:TMUBMUSD10Y breaks below 2.95%, that’s a clear green light to make long-term Pursuits one of your best asset allocations. Many people want to pick bottoms in stocks. I’m much more interested in buying Treasury bonds than anything else.

Also read: ‘We’re in big trouble’: billionaire investor Druckenmiller believes Fed monetary tightening will squeeze economy in 2023

Plus: It was the worst September for stocks since 2002. What does that mean for October.

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