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Is a US recession already a foregone conclusion? Is that really what the markets, the fundamentals and the Federal Reserve are telling us? I’d argue that the set-up at the moment is more “binary”. Two starkly different outcomes look possible.

Certainly, the US economy has cooled from the torrid pace that had surprised all those economists that shoot off their guesses about the future of this $13,000bn economy in the first few months of the year.

Now, after they all chased the strength by upping their estimates for the rest of the year, the economy is beginning to surprise them on the downside. But just because the economy is cooling (or has already cooled) and is weaker than most traders and economists expected, we cannot necessarily extrapolate a Snoopy-like Joe Coolness out for the next few quarters or years.

Though I have been a rather vocal bull for most of the past three and a half years of running my fund, on May 10 I pulled my horns in, moving almost entirely into cash and Microsoft except for my long-held Apple and Google positions. It was one of the luckiest timing calls of my life.

The reasons for the move were threefold and I think we should look for a reverse of those factors to help guide us as to when (or whether) to get back into the market:

1. The chatter on the technology conference calls turned from “we can’t stay up with demand” to “we are comfortable with our inventory levels”. It is now at the stage of “we’ve got to work through some inventory.”

2. Most commodity stocks went parabolic and their customers were scrambling to secure five, seven or 10-year supply deals.

3. The world’s central banks seemed to have crossed the fine line between “please take this money” and “if you want capital, it’s gonna cost you”.

The good news is that the tech markets – especially the volatile and often-leading semi-conductor sector – have tried already to price in the inventory problems, as the decline of more than 30 per cent in the SOXX index indicates.

Many former high-flyers and the fastest growers, from Broadcom to Qualcomm, warned about the second half of the year. Also good news is the decline of more than 30 per cent in many commodity indices, which in May blew the top off their parabolic charts. Parabolic no longer describes that action.

Then there are the central banks, which have continued to use the tools at their disposal, including interest rate increases, to sap liquidity from the world’s markets. Housing in the US has all but collapsed and the inventory situation in that sector is far from being worked through.

And that leads me to what is really on most traders’ minds. Just how binary is this set-up?

On the one hand, if the US heads into recession and housing really collapses, can we avoid an outright depression? If the economy continues to cool and those housing and tech inventories continue to pile up, things could get really ugly really fast. The markets would probably continue to falter, reducing multiples and taking growth stocks to yet lower lows.

Of course, it’s not as if the Fed and the markets will just stand still. At some point we have to figure that the politically motivated Fed (yes, the Fed is politically motivated) and many other central banks will have to step in and work to reliquefy the world’s economies – and markets.

And then, of course, we’d be back off to the races. I use the term “techo bubble” to refer to the possibility that such a reliquefication would fuel another speculative fervour in the market. Tech would probably lead once again as growth became the mantra and all that liquidity would boost the fundamentals and the markets in a fantastic reflexive manner that fed on itself in a virtuous cycle.

And if the Fed acts too late and/or if the reliquefication works only to devalue the world’s currencies and immediately spike inflation? Depression, right? It’s happened before. Couldn’t it happen again? Talk about binary! In Alan Greenspan’s final days as Fed chairman, economists used to talk about the Fed’s supposed conundrum. But I think that, not unusually, the economists’ timing was wrong. It is now that the conundrum is headed the Fed’s way. Is the set-up really so binary that the Fed has to choose between another bubble or another collapse?

Of course, maybe things will all work out smoothly and the Fed’s actions, the inventory issues, the action in commodities and the rest of it are just noise. Then again, as AC/DC might tell us, “Rock ’n’ roll ain’t noise pollution” – and I don’t think this set-up, which is likely really to rock or just roll over, is noise.

I’m anxious to get back to trading and investing and being my usual bullish self. But not until the noise dies down.

Cody Willard is a hedge fund manager at CL Willard Capital
cody@clwillard.com

Copyright The Financial Times Limited 2017. All rights reserved.
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