It was just last month when we checked in on BofA economist Ethan Harris who, in May of 2015 derided the “perma-bear” crowd for crowing about an abysmal Q1 GDP print.
“Looking ahead, it is much too soon to declare victory, but we expect the data to improve in the months ahead as seasonal and other distortions fade,” Harris concluded, suggesting that if the double-adjusted data continued to “improve”, BofA’s economics team would be able to proclaim that the bears had been vanquished once and for all.
8 months later, Harris admitted that “a series of shocks have undercut [his] optimism.” Those shocks are, i) slumping oil prices, ii) the demise of HY, iii) generally terrible news from the US industrial sector, and iv) market “moodiness” related to China and oil.
Of course all of those factors were already at play at the beginning of last year. Saudi Arabia had already begun its war on the US shale space which would have been all the evidence you needed to predict both the collapse of oil prices and the turmoil in HY, it was already abundantly clear that US corporates were eschewing capex for buybacks, and if you didn’t see the writing on the wall in China by January of 2015, then you can’t really call yourself an economist.
“Who could have possibly anticipated these ‘shocks’"?, we asked last month. “Oh yes, those pesky perma-bears, who actually looked at all economic indicators, not just the ones goalseeked to validate some initial (and erroneous) hypothesis,” we said, answering our own question as we are so very often forced to do.
BofA went on to lower their 2016 GDP forecast from 2.3% to 2.1%.
On Wednesday, Harris is back and although he’s doing his best to stay positive (bless his heart), he’s willing to admit that “recent market fragility” will likely force the Fed to lean more dovish and he also says “the stock market is pricing in a 50% or so probability of a recession.”
Apparently, Harris is also "surprised" by the strength of the dollar (because who could have seen that coming given the epic diveregence in monetary policy between the Fed and other DM CBs) and the tightening in financial conditions. He also concedes that "Q4 GDP growth was particularly weak." Here's an excerpt from Harris' latest note:
It has been an ugly start to the New Year: at Friday’s close, the S&P 500 was down 8.8% year to date (11.6% off its November high), 10-year treasury yields were down about 50bp ytd, and there had been a further widening in high yield spreads. Capital markets seem to be pricing in a 50% or higher probability of a US recession. For example, a simple probit model shows that the 6 month growth rate in the S&P500—falling by 8.8% from July to January — is signaling a 49% chance of a recession starting sometime in the next 12 months (Chart 3). Our rates team has developed an adjusted yield curve measure that signals a 68% probability of recession.
But don't worry, Harris believes the market as well as BofA's rate team may be "peddling fiction." Here's why:
In our view, the weakness in 4Q GDP reflects both the erratic nature of recent GDP releases and some temporary factors holding down growth. The weakness in the second half of last year also reflects three partly temporary headwinds.
Inventories rose about $113bn in both 1Q and 2Q last year. That is about double the sustainable pace. With moderate sales growth, companies were forced to slow production to slow the accumulation. Investment has now slowed to $69bn, slicing 0.7pp and 0.5pp off of growth in the last two quarters. As a result, we believe the adjustment is largely over: we expect a 0.2pp drag from inventories in 1Q and no drag thereafter. A similar story applies for the collapse in the mining sector: the worst is behind us. The third, and most important, headwind is the strong dollar.
And while Harris doesn't necessarily see the strong dollar problem as being "temporary" like the other headwinds facing the econony, he does say it's important to remember that "the equity market is not the economy" (an effort to downplay the market's pricing in of a looming recession).
Harris is right. The equity market is not the economy. Although judging by the Fed's new reaction function, we're not sure Janet Yellen agrees.