Awakening the Bear

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If you’ve been following my tweets—especially on @behavioralmacro—you will have noticed a shift in my long-standing bullishness over the past week. Here’s an edited DM to a friend who is more bearish bonds than I am that kinds of lays out the bare bones of why. I welcome questions.

Remember, predictions of a bear market or recession are mostly bullshit. These are complex behavioral phenomena that defy timing. But, like a good doctor, even if you may not be able to forecast when or if a patient will have a heart attack, you can identify vulnerabilities to one, look out for early warning signs, and prepare measures in the hope that if it happens you will recognize it early and come out strong on the other end.

I’ll be honest: I’m less bullish on virtually all time horizons than I was even a couple of weeks ago. Base case still a longer cycle in the US, China muddles and the EU doesn’t implode. But odds of this have dropped and risks are more skewed to the downside.

My bullishness in the risk cycle has been underpinned by three things: 1) the old Rudiger Dornbusch saying that “you can’t commit suicide jumping out of the basement window” and 2) deep, pervasive PTSD from the GFC, and 3) various asset shortages. I think the PTSD and asset shortage parts are still broadly operative, but the US economy is no longer near the ground floor. We’re not on the top floor either, but the labor market and corporate positioning have been pumped up enough by natural cycle progression goosed by recent deficit spending that a meaningful shock from home or abroad could lead to a fall, even if not a deadly one.

Spot growth does look decent right here, right now, but we are definitely more vulnerable to negative shocks than we were before the fiscal impulse, even if the financial sector is clean and a proper recession isn’t that plausible to me. But our top end growth is clearly limited, and politics are about to get a lot more noisy, I’d be wrong if 2019 growth turned out anywhere close to 3%, and unless we pick back up closer to that, I don’t think rates are going to get away from us, and a market dislocation on every growth scare seems likely. I’ve locked in a good return already in my investment account this year. I like the idea of moving to cash and taking an option on being able to reinvest into a dislocation. I’ll take the risk that the market gets away from me to the upside. I don’t think–even with the artificial beginning-year marker–that the SPX is going to put up a 30% year. In my Trading book, I’ll be ready to be active either way, depending on more tactical opportunities.