Dr. Michael Burry, known for his great short film during the 2008 financial crisis and profiting from billions, has expressed strong opinions about the current market downturn and thinks we may be just one step away. halfway through this bear market.
In this article, we take a deeper look at macroeconomics and why he might be right, and we might have another decent downturn lurking around the corner.
We are halfway
The biggest concern stems from a tweet Dr. Michael Burry made a few weeks ago, when the S&P 500 was trading around 1-2% lower than its last Friday close. In this particular tweethe said:
Adjusted for H1 2022 inflation, S&P 500 down 25-26% and Nasdaq down 34-35%, Bitcoin down 64-65%. It was multiple compression. Next, the squeeze on profits. So maybe halfway.
We think Michael Burry is right to express his concern here, as we think some important economic indicators could reflect an impending consumer recession and the first half of the year may have been mostly multiple compression.
A very interesting indicator that we watch is perhaps the recent development of copper and gold, as they have been excellent predictors of the economic situation in the past. Namely, gold is widely considered a safe haven for investors, while copper is the exact opposite. Gold generally performs well in times of inflation, economic turmoil, political turmoil, etc.
Copper is commonly referred to as “Dr. Copper” or the commodity with a Ph.D. because it is considered a particularly strong signal of economic health. Copper typically performs very well when the global economy is booming, and even more so today as it is used as a key component in electric vehicles, which typically contain twice as much copper as internal combustion vehicles.
As you can see in the chart below, copper prices have fallen 30% over the past 3 months, while gold has fallen 13.3%, despite record high year-on-year inflation of 9 .1% earlier this week.
Copper falling more than 30% in such a short time indicates that there really isn’t much confidence in a strong and healthy global economy, while gold, on the other hand, may be a a sign that inflation may have finally peaked, or it may have been a crowded trade like energy stocks which also fell recently. It may also be worth noting that copper tends to be more volatile than gold.
But it fits very well with Michael Burry’s story that we could be facing a consumer recession by the end of this year or early next year. Dr. Michael Burry also alluded to this in his thesis on supply chain, specifically how supply chains can live”Boost Effects.”
These bullwhip effects, which Michael Burry refers to, boil down to a shortage of goods at the end of last year, followed by overproduction, following which we are now seeing huge piles of inventory. Note that the graph below shows inventory figures on an annual basis, and still needs to be multiplied by 12 to get an annualized percentage rate.
We agree with Dr. Burry and believe that although inflation has peaked, there is a good chance that the United States will enter a very deflationary spiral that will bring inflation down by the end of it. this year, even as the Fed continues to tighten very aggressively at a time when growth is slowing and layoffs are happening.
Which could lead to disinflation later this year, with a consumer slump and the Fed reversing/cutting interest rates sooner than expected and continue the cycle. He confirmed this belief with a witty statement on Twitter:
Q; In 2022, what does Christmas in July bring? A; An overstocked disinflationary consumer recession at Christmas.
Is the economy as strong as it looks?
Although very positive news came out on Friday, it indicated that retail sales rose more than analysts had expected in June, by 1% against an estimate of 0.9%. This gave investors a positive signal that consumers are still strong despite all the ongoing inflation. However, this figure had not yet been adjusted for inflation, which came last at 1.3% MoM, meaning that actual sales were actually slightly negative.
Another factor added by Michael Burry is the amount of revolving consumer credit, which has again reached pre-pandemic levels. This happened when consumer purchasing power was destroyed after negative real wage growth due to runaway inflation.
And it won’t get better with the Federal Reserve raising interest rates 75 basis points at a time, something that hasn’t happened since the 1990s. Soon, that credit card debt will get a whole lot more Dear.
And consumers also don’t seem to have been able to save much during this period of inflation, having spent billions of dollars in stimulus spending. The personal savings rate has now fallen to its 2008 low of 5.4%.
According to Fed data, the amount of personal savings doesn’t look too bright either: the amount of personal savings for the first quarter of 2022 is at 2013 levels, after rising dramatically over the past last two years.
At present, businesses can still pass on the cost of inflation to consumers without having too much of an effect on growth. But that could change very quickly, as inventories pile up, consumers dry up, and businesses and manufacturers therefore have to slash profit margins. And before you know it, you have an earnings recession.
Wall Street may have priced in the current inflation that has hopefully peaked, but the deteriorating earnings numbers for the second half of this year are far from discounted. According to FactSet data, analysts recently lowered their earnings estimates for the second quarter of 2022, but not at all for the second half of 2022, which we believe makes no sense given the macro data.
All indicators point to a very imminent economic slowdown, with, for example, the 10-2 Year Treasury Yield Spread inverted at -20bp. This is a very strong reversal, which can also be a clear signal to the Fed that it may be pulling too hard and destroying the economy in an attempt to bring inflation down too quickly.
Even the Atlanta Fed’s GDPNow tracker estimates a -1.5% decline in GDP for the second quarter, after first-quarter GDP was negative, suggesting the US may already be in a technical recession. And yet, earnings per share have not yet been revised downwards, which suggests that more suffering awaits us.
However, we think some initial relief may be on the way as positive numbers on lower inflation are coming out. It should also put the brakes on the Fed and make it more likely that it won’t raise rates as aggressively as it has done thus far. Many analysts speculated about a 100 basis point interest rate hike after inflation hit 1.3% yoy and 9.1% yoy in the latest CPI figures, after having initially counted on an increase of 75 basis points.
But following the release of the recent University of Michigan survey, which indicates a sharp decline in consumer expectations for 5-10 year inflation, which has fallen the sharpest since October 2020. It seems to us that the The Fed is very concerned about not being able to put the genie back in the bottle when it comes to long-term inflation.
Without a doubt, the most important indicator that still points to a very rosy economy is the unemployment rate. Although this is generally considered a lagging indicator, as we are starting to see a lot of layoffs, especially in the tech industry.
For example, in the chart below, we have overlaid the unemployment rate and the effective federal funds rate. As you can see, the upward trend in the unemployment rate is usually a lagging indicator when interest rates have historically risen.
Where is Michael Burry hiding?
Michael Burry’s vote of no confidence in what is about to happen in the economy is also reflected in the positions he is said to have taken. For example, in his last 13F filings 2 months ago with the SEC, we can see that he took a put option worth almost $36 million on Apple.
He may or may not have sold that position, but chances are he’s already profitable on those positions, as Apple has seen a more than 10% decline since disclosing those put options.
He has also held roles in companies with mostly strong FCF, large balance sheets at low multiples. Some of his positions include Alphabet (GOOG) (GOOGL), Booking Holdings (BKNG), Bristol-Myers (BMY), Discovery (WBD) and Meta (META).
With Federal Reserve tightening at a blistering pace, economic indicators pointing to a recession, and earnings forecasts yet to bottom, things could get worse before they get better.
In the meantime, however, we and Michael Burry continue to take advantage of this buying opportunity, as it is a dangerous game to try to time a dip. We believe there are plenty of opportunities to buy quality stocks with strong balance sheets and strong business models that generate plenty of FCF and can easily survive the next recession.
And more importantly, it could get a huge boost if the Fed changes course and starts cutting interest rates sooner than expected, as Dr. Michael Burry seems to be predicting.