- Several warning signs including the “mother of all bubbles” are adding up to diagnose the next recession, according to Joseph Zidle, the chief investment strategist of Blackstone’s private-wealth solutions group
- He is concerned that investors are treating these signs as random events even though they are all linked — just like the 2008 crisis was the culmination of many separate risks.
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Economic crises are easier to diagnose with the benefit of hindsight. But how do you identify one while it is brewing?
Joseph Zidle, the chief investment strategist of Blackstone’s private-wealth solutions group, is adopting the framework his boss used to foresee the housing crisis over a decade ago.
Blackstone CEO Steve Schwarzman espouses the idea of hunting for “discordant notes.” These refer to trends in the economy and markets that easily pass as isolated events but combine in a dissonant, troubling fashion.
As a case in point, the surge in housing prices and the collapse of The Reserve Primary Fund due to its exposure to Lehman Brothers seemed like two separate issues. However, we now know they were part of the same awful financial crisis.
The next recession will likely be no different according to Zidle: Many warning signs that easily pass as isolated are adding up to forewarn investors.
Today, the loudest “discordant note” that he hears is in sovereign debt, which he says might be the “mother of all bubbles.”
He observes that investors have characterized the prevalence of negative government bond yields — a consequence of soaring prices — as normal. Some investors have stopped questioning whether it’s a bubble even though the global stock of negative-yielding debt adds up to an unprecedented $13 trillion.
The unique trouble with the run up in bond prices from Austria to Germany is that unlike other asset classes, fixed income has historically been used as a ballast for portfolio swings. However, bonds themselves have become subjected to huge moves like Austria’s 100-year bond that doubled in price within two years. And, in some cases, investors are speculatively buying sovereign bonds for their price appreciation instead of their steady yields and protection.
While Zidle is not alone in decrying the run up in bond prices or in calling them the greatest bubble ever, he is warning that investors are too easily dismissive of this and other signals that show something is wrong.
“The failures in the repo market, negative-yielding debt, a deeply negative term premium, trade conflicts around the world and a collapse in manufacturing all seem unrelated right now, but I don’t think they are random,” Zidle said in a recent note to clients.
He does not expect a recession within the next six months. But he also does not expect this expansion to persist for up to two more years.
Providing the wrong solution
Ironically, one of the factors that would ordinarily delay another crisis — central bank monetary policy — could end up being ineffective this time, according to Zidle.
He says that central banks are placating investors rather than their economies by pumping liquidity into financial markets and cutting interest rates in a coordinated fashion.
For example, US stocks have rallied strongly this year as the Federal Reserve has shown its readiness to keep the expansion going by cutting rates. However, these same rate cuts are not massively moving the needle on how easy it is for consumers to borrow money.
“Even a year ago, when central banks were tightening monetary policy, credit conditions were not meaningfully more difficult than they are today,” Zidle said. “So, if tight credit markets aren’t the problem, easier money is unlikely to be the solution.”
The real problem is trade, in his view. Solving this political issue would lift business confidence, keep hiring strong, and maintain the expansion.
For investors, the other solution is a resurgence in corporate earnings growth, which would give stocks meaningful upside that is not reliant on the Fed. Cyclical and low-quality stocks — or those with weak balance sheets — should outperform in this scenario, according to Zidle.
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