A Look Ahead at 2023 Part II

In the first part of our look ahead at 2023 which we published on January 29, we focused entirely on interest rates. That’s for good reason; Interest rates have been, and will continue to be, the dominant factor affecting the stock market.

But it’s certainly not the only factor. The threat of a recession and a possible debt ceiling crisis in July will also have an effect on the stock market.

The most important of these two issues is the threat of a recession. Although a recession has been a stock market worry for the last year, currently, the stronger worry is that the economy is still growing so fast that the Fed will have to raise rates higher than expected to cool it down.

Not at All Clear We Will Have a Major Recession

So, it is not even clear that there is a consensus that a recession is a big risk factor. That’s in part because 4th quarter GDP growth was 2.6%, we have the strongest labor market since 1969 and consumer spending jumped a healthy 1.8% in January.

So, how can we have a recession if growth is still quite good? The reason it is still a possibility is that interest rates have increased. That is hurting the housing market and auto sales among other capital goods industries. Also, the booming technology sector is cutting staff. It greatly over-hired during the Covid crisis and is now facing a slower economy than expected. Plus, the lousy stock market may encourage wealthier people to spend less at some point.

However, all of these factors will likely slow economic growth, but they may not be enough to push us into a major recession – two consecutive quarters of significantly negative economic growth.

And, there could be offsetting factors: If the housing market starts to hit big troubles, the Fed could easily lower mortgage rates by buying mortgage bonds as it has in the past. As for the loss of tech jobs, many of the people who have been laid off by the tech industry are so far having little trouble finding jobs in other industries. Plus, if the stock market continues to recover, that could easily support greater spending by the most important group in discretionary spending, the upper middle class.

The Biggest Reason We Will Have Continued Economic Growth Is the Reason No One Wants to Talk About: Huge Deficits

One of the biggest reasons it is hard for the US economy to fall into a major recession is that we are going to run big, big, very big government deficits. In fact, the Congressional Budget Office just announced that they expect the US government to run an average deficit of TWO TRILLION DOLLARS A YEAR for the next TEN years. And their estimates of the deficit are usually pretty conservative!

To put that in perspective, the highest deficit we ran after the 2008 Financial Crisis was $1.4 trillion. Even during the Covid Crisis we only ran a deficit of $2 trillion for two years in 2020 and 2021.

So, running huge deficits in the future is great for growth. That’s because we are borrowing and immediately spending an amount equivalent to about 10% of our economy – and we will never pay back any of this borrowing! That is a huge stimulus!

Also, we don’t have to pay any interest on it – we just borrow more money to cover the increasing interest costs. And we never pay down the debt because we can just borrow more money to make the payments.

Now if that isn’t a recipe for stimulating growth, I don’t know what is.

And if that isn’t a recipe for a huge economic disaster in the future, I don’t know what is.

Hence, no one wants to talk about it as a big part of the growth outlook for the US. But it’s nothing new. If we hadn’t run big deficits every year since the Financial Crisis, we would have had no growth.

Running big deficits has been the key to our economic success since the Financial Crisis. The only difference now is that we are going to run much bigger deficits.

Debt Ceiling Crisis is Coming This Summer, but Will Be Temporary – and a Buying Opportunity

The problem with not raising the debt ceiling is that it doesn’t solve the problem: We’re spending too much. Not raising the debt ceiling just means we default on our debts. It doesn’t mean we cut spending. Of course, defaulting on our debts would cause a massive decrease in spending because the government couldn’t borrow anymore. But it also means the total collapse of our stock, bond and real estate markets and an almost immediate 25% to 50% contraction in our economy.

Even talking about it seriously and taking some actions in the direction of not raising the debt ceiling will rattle the markets enough to get 6 Republican representatives to vote with the Democrats to raise the ceiling. That’s all the votes that are needed to raise the ceiling. Many Representatives have significant stock, bond and real estate portfolios themselves, as do many of their constituents, and they won’t want to see them wiped out.

Plus, since it is only six people, it is relatively easy for Congress to “bribe” those six people by making changes that would benefit their constituents or changes they would like that the rest of Congress may not like, but will agree to, including some spending cuts. But, you can bet your last dollar those spending cuts won’t be very big and the Congressional Budget Office prediction of $2 trillion annual deficits for the next 10 years come true.

Raising the Debt Ceiling Is a Temporary Fix Creating a Massive Problem: Eventually the Government Won’t Be Able Issue More Debt

Don’t think for a minute that raising the debt ceiling is a solution to our problems. But it brings immediate rewards by postponing a huge problem which is: The government’s ability to borrow money will still be stopped.

But it won’t be stopped by the government. It will be stopped by the financial markets crashing. And that will happen when, as we said in the first part of our 2023 Outlook, and it’s worth repeating:

1. Inflation, as measured by the CPI, is over 10% and rising

2. The Fed is massively printing money

3. Ten year interest rates are also rising above 10%, despite the Fed’s massive money printing