The Federal Reserve keeps telling the financial markets to take its tough talk seriously. Yet many investors and even Wall Street professionals are pricing stocks as if a return to the good old days of easy money and low interest rates is just around the corner. They’re convinced that the U.S. central bank is about to end its rate hikes and then pivot — lowering rates and bringing the U.S. economy to a soft landing that ushers in a new bull market for stocks.
Keith McCullough isn’t having it. The CEO of investment service Hedgeye Risk Management expects the Fed’s restrictive actions will squeeze the U.S. economy too tightly. McCullough is keeping client portfolios geared to his view that in its zeal to curb inflation, the Fed ends up driving the economy into a recession — crushing consumer demand and the ability and flexibility of businesses to borrow, finance debt, cover expenses and meet payroll.
“Unfortunately the country is going to have to deal with that,” McCullough says.
Until the economic cycle shows signs of turning, McCullough is steering investors to precious metals, U.S. Treasury bonds and stock-market sectors that focus on what people need, rather than what they want. Think health care and utilities.
In this recent interview, which has been edited for length and clarity, McCullough outlines his current outlook for the U.S. economy and the financial markets in the second half of the year, and recommends investments you’ll want in your portfolio to weather the challenges McCullough expects investors will face.
MarketWatch: When we last spoke at the end of January, you were adamant about holding secure assets including gold, silver and defensive stocks to weather a coming recession. Has your outlook changed?
McCullough: No. The recession will be deeper and potentially more protracted than even I think. What happened with SVB and the other banks is not inconsequential. The credit line of America is impaired. In a bear market these things appear quickly and then all at once. It’s why it’s really hard to see a recovery in the back half of 2023. Commercial real estate is at the core of American leverage. You have massive supply, vacancy rates skyrocketing, and $1.5 trillion in commercial real estate debt maturities is coming due.
MarketWatch: In that same interview, you slammed the Federal Reserve and its Chair Jerome Powell, calling the Fed “complicit” in inflating the “Mother of All Bubbles” with liquidity — which we’re paying for now through higher interest rates. What’s your view of the Fed now?
McCullough: The Fed is way late and they’ve already screwed it up. The Fed has made their second massive mistake. They underestimated inflation and now they’re underestimating the recession. They are calling for a potentially mild recession in the back half of 2023.
We’re in a recession now. Unfortunately the country is going to have to deal with that. We’ve empowered an unelected central planning agency to be categorically wrong on forecasting inflation and now recession. If you’re going to be hostage to that, you’re going to have to deal with the ramifications.
MarketWatch: Given your outlook, what assets are you avoiding now?
McCullough: We’ve been bearish on growth stocks, inflation and cyclical stocks including financials and industrials. What’s interesting about that is we finally have 21 different asset allocations on the long side. Once you start to slow into a recession, bond yields start to fall irrespective of what the Fed thinks. Eventually the Fed figures it out and assumes a rate policy that the bond markets have already assumed. The bond markets have already figured this out and so has gold.
“ ‘Investors just want their bubble back.’ ”
MarketWatch: Which investments are on the long side of the Hedgeye ledger?
McCullough: There’s a lot of long equity positions; it’s just not what everybody owns. Once bond yields start going down, people look for bond proxies. So we’ve bought utilities with the SPDR utilities ETF, ticker XLU
XLU,
We have defense-industry exposure through the iShares U.S. Aerospace & Defense ETF
ITA,
health-care stocks through Simplify Health Care ETF — ticker PINK
PINK,
We hold materials-industry stocks through XLB
XLB,
We’ve added Japan with EWJ
EWJ,
and South Korea with EWY
EWY,
We’re long gold GC00, using the ticker GLD GLD, silver SI00 through SLV, platinum PL00, and the ETF for that is PPLT PPLT. We’re long physical gold, with the ETF AAAU AAAU. We’re long duration using the 20-year Treasury ETF, ticker TLT TLT, and the intermediate-term Treasury ETF, ticker IEF IEF, plus the 10 year Treasury and, through an ETF with the ticker IIGD IIGD, investment-grade defensive credit.
We used to be long Tesla
TSLA,
; we were long crypto, long growth — all that stuff. But our process goes both ways. When the cycle turns we reverse it. By the time the Federal Reserve figures it out and cuts interest rates, my long gold position will have gone up faster. What’s most interesting to me is investor behavior now. People still are buying polka-dot coins and Tesla.
MarketWatch: Many investors do believe the music will never stop, especially when Wall Street and others tell them what they want to hear.
McCullough: Investors just want their bubble back.People want to be told a story. It’s much easier to believe a story than it is to do the work. When you’re coming out of a growth bubble it’s easy to believe a lot of things about the future, because your past experience was a period of growth. Year-over-year U.S. GDP accelerated over 12% in the second quarter of 2021.
If you go back and look at any of these strategies — happy talk, growth investing, the future is going to be about Elon Musk burrowing tunnels — anything is believable after growth has accelerated. And in this case you also had money-printing and government handouts. It was all there. Just tell me a story. It’s one thing to believe; it’s another to understand.
More: Fed lending survey has perfect track record when it comes to foreshadowing recessions: strategist
Also read: Fed ‘accident’ could slice 20% off the S&P 500, stock market strategist David Rosenberg warns. Here are 3 ways to protect your money now.
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