Why Trahan Believes The Much Touted Soft Landing is a Pipe Dream

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Richard Dufour of La Presse reports François Trahan sees the stock market fall by 35% (translated from French):

The stock market will end 2023 in the red, according to forecaster François Trahan. There is no chance of avoiding a recession, according to him. He even believes that the S&P 500 index risks falling by 35% within 18 months.

“At its trough, the S&P 500 index will drop to around 2,800 points,” says François Trahan during an interview with La Presse. This flagship index is currently at 4275 points.

François Trahan is visiting Montreal this week. He came from Virginia, where he now lives, to meet clients and to participate this Thursday at noon in an event organized by the CFA Montreal organization downtown. Admitted to the Hall of Fame of Institutional Investors as a strategist in 2016, François Trahan notably predicted the end of the speculative real estate bubble in 2007.

“We have everything to have a severe recession,” he says. “I don't know if there will be a financial crisis, but the risk is very high at a time when investors no longer believe in this. The story has only just begun. The worst is ahead of us.”

The 54-year-old strategist explains that the trough of a recession occurs two years after the highest point interest rates reach.

Towards a trough in 2025

“If rates have peaked, the economy will be at its worst in the third quarter of 2025. For leading indices, like the stock market, this is 18 months after the peak of interest rates, so six months before the trough of a recession. If we assume that rates are currently at their highest level, the stock market bottom will therefore be reached in March 2025.”

François Trahan expects leading indices to deteriorate over the next three months and for the stock market to end 2023 with a decline for the year despite the gains recorded so far since January 1.

Financial data firm FactSet reported last Friday that Wall Street analysts expect the S&P 500 to rise 19% over the next 12 months. FactSet obtains this figure by aggregating analyst target prices for all companies in the index.

“Opinions around me have changed a lot since last fall,” says François Trahan.

“If previously a majority of my clients believed in a recession, a majority of them now believe in a slowdown and believe that we are on the verge of emerging from it. They believe the story pushed by the Fed of a soft landing for the US economy.”

“What’s coming will surprise a lot of people”

The thesis of a soft landing actually still seems to hold water south of the border. The resilience observed reflects an American consumer who continues to spend even if his morale is affected. If confidence indices remain low, consumption statistics continue to defy sentiment because the job market is holding up.

“What is coming will surprise many people and Wall Street economists will be exposed over the next year, they who today almost all advocate a soft landing,” said François Trahan, taking care to weigh his words.

“About 55% of economists cannot identify a recession that is six months away. Many cannot do it even when the recession has started,” adds the man who is now self-employed after launching the firm Trahan Macro Research.

“Consumer economies are sensitive to changes in interest rates. With 68% of its GDP coming from consumption, it is the American economy that responds the most to a change in interest rates,” he says.

“The part that people have the most difficulty understanding is the delay or space-time between the interest rate change and its impact on economic activity.”

--François Trahan

“Rates started rising in early 2022, so recession was always a question of 2024. In the third quarter of 2025, the economy will still be in trouble. When rates start to fall sustainably, we can start talking about a possible recovery. The economic impact of what the Fed has just done is before us. This is really the story of 2024 and 2025.”

According to him, we should not be too upset about the stock market surges in the indices in the current market. “We are going to have other bear market rallies where people will think that the recovery has arrived. In a typical bear market, there are three.”

François Trahan caused a stir last November when he said on the set of a public affairs program on TVA that he anticipated an “apocalyptic” situation for the years 2023 and 2024.

In his opinion, an “economic apocalypse” results in a rising unemployment rate and “probably” a financial crisis. “Maybe more than one,” he says.

Chales Poulin of Les Affaires also reports when it comes to the economic slowdown, the worst is yet to come, says François Trahan (translated from French):

The American and Canadian economies may have slowed down in 2023, but the worst is not yet over, says stock market strategist and economist François Trahan.

Invited by CFA Montreal to come and present his point of view on the economic and stock market prospects for the months to come, the man who was admitted to the Hall of Fame of Institutional Investors in 2016 and who is considered a star on Wall Street, did not put on white gloves and painted a fairly pessimistic portrait of the economy for the next two years: the lowest trough should occur in 2025.

Based on recent data from the American economy, he believes that a soft landing is difficult to envisage.

“It takes two years before changes to the key rate have an impact on the economy,” insists the Quebec forecaster several times during his conference. “When you try to identify the bottom of a recession, you find the point where interest rates are highest and add two years.”

This summit is today, he notes. “In September 2025, the economy will really be in trouble,” he says.

Similarly, stock markets historically react by bottoming out 18 months after the highest interest rate. François Trahan notes that the 30-year fixed bond rate was 7.83% in the United States, and the average mortgage renewal rate was 7.98%.

“We should thus reach the bottom of the stock markets at the earliest in spring 2025,” he says.

Problematic indicators

In addition to the fact that the current economic slowdown is global, François Trahan notes that several indicators are problematic among our neighbors to the South.

American industrial growth is approximately neutral, and consumer spending is in decline (-0.2%).

The credit crunch situation also worries him.

“The American Federal Reserve (Fed) has just carried out the most aggressive rate increase since 1979,” notes the Quebec forecaster. And what's a little strange is that banks have tightened credit conditions at the same time as the key rate increases, whereas typically, they begin this process at the end of the increases. This is something we have never experienced and which will add another economic pressure.”

Exit doors blocked

Usually, two exit doors can open during a recession, he recalls. The first is strong growth from a major economy elsewhere in the world (the reunification of Germany in the early 1990s or the growth of investment in China in the 2000s).

“We cannot currently identify a large enough growing economy that could help us,” he emphasizes.

The second is state tax policy. The problem is that the United States has its highest level of debt since World War II.

“The problem of public finances in the United States will limit their response to the crisis,” submits François Trahan.“ Americans will not be able to spend without consequences.”

He also recalls that one of the starting points of a recession remains the explosion of the deficit after an economic slowdown.

Canada

François Trahan believes that the coming months will be “difficult” for the Canadian economy. The country, which exports a lot, is highly dependent on what is happening elsewhere in the world, and its main business partners, the United States, Europe, China and Japan, are all currently experiencing problems.

“Economies that depend on exports are more sensitive to recessions,” he says. The fact that the situation is global adds enormous risk.”

Recovery or recession?

To those who argue that the economy is rather in recovery, he responds that the United States is rather in a situation of "bear market rally", a short and sharp increase in prices included within a longer period of decline of stock markets.

Rather, it points to the fact that since World War II, during the last 13 rounds of Fed rate hikes, there have been just as many recessions. For the same period, when inflation exceeded 5% in the United States, there was a recession. And during the last eight inversions of the bond yield curve, there has been… a recession.

“I repeat: it takes two years before rate changes affect the economy,” he warns. I don’t see how we can, in this case, talk about a resilient economy at the moment because all the increases have not yet had their effect.”

François also had an interesting Q&A with Richard Dufour of La Presse (translated from French):

What is your daily routine?

I'm an early bird. I get up around 4:30 a.m. And I usually start my office day around 5:30 a.m. I do 90% of the things I need to do in a day by 8:30 a.m. After that time, I start calls with customers, team, etc. It's very rare that I end my day after 5 p.m. unless I have a call with Asia or something.

What is your best habit?

I stopped eating sugar and it changed my life. I was very sick in 2020. I had long COVID-19 before we even knew what long COVID-19 was. I struggled for seven months, two of which were very difficult. It changed many of my habits. I became obsessed with health. Previously, I stood in front of the vending machines to buy a chocolate bar every day in the afternoon. I have more energy today than I had 30 years ago. I feel like I'm 14.

Do you have a guilty pleasure?

Unsweetened energy drinks. It’s a different version of coffee. It’s a stimulant. It’s a bit like my replacement for chocolate bars.

Who do you admire in the business world?

I have always had a lot of admiration for Jeremy Grantham, of the investment firm GMO, from Boston, and for Ray Dalio, of Bridgewater [an American hedge fund]. I don't always agree with them. But they make me think and, ultimately, that’s what I try to do with my clients, make them think.

What app could you no longer live without on your phone?

I really like DuoLingo [an application for learning languages]. My kids use it too. If this application had existed when I was young, I am convinced that I would speak seven or eight languages. For the past six months, I've been obsessed with Worldle, a game that involves guessing a country in six attempts based on an image. [Not to be confused with Wordle, a game that involves guessing a five-letter word in six attempts.]

What are your hobbies ?

I go to the gym five days a week. I have five children. I often start my Uber shift at 5 p.m. with a girl who goes to the theater, one who plays soccer, and another who has a dance class. That leaves me little time, but what we do a lot as a family is hiking.

What were your best predictions?

The one that people know best is that of the financial crisis because in 2007 I wrote a document on speculative real estate bubbles. I published a book in 2010 which talked about a change in economic regime which I called “The Era of Uncertainty”. I emphasized that growth stocks were going to dominate the markets for different reasons. It took a while for it to become dominant, but that's exactly what happened. I also published an analysis in 2014 where I talked about the end of the Chinese model. The things written in this document have almost all happened. I was talking in particular about the price of a barrel of crude oil which was worth almost US$100. I predicted it would fall to US$20 and nine months later it fell to US$24. I could also highlight the moment when I went bullish (optimistic towards the markets) in March 2009 and when I made a similar decision in the spring of 2020.

And your worst prediction?

The majority of clients buy our research primarily to find out how to position their portfolio. Let’s say I learned a lot in 2017. It wasn’t my best year. I have given myself a report card at the end of every year for 20 years and in 2017, I gave myself a “D”. I completely missed market leadership in 2017 when it is generally in the positioning of sectors and market factors that I obtain the best results in my research. That year, growth and consumer discretionary stocks did well, but certain cyclical factors also worked, which you rarely see together.

The ideal retirement?

I have a bit of the feeling of being there and experiencing it at the moment at 54 years old because I have surrounded myself with former colleagues whom I appreciate very much. It’s the most satisfying part of my career. I'm doing what I love to do, which is research. It’s very rewarding to be able to educate people about macroeconomics. It's more of an early retirement, but I wouldn't go back to work for a bank in New York.

What word or phrase can you no longer stand? 

"Soft landing".

Haha! I can't stand soft landing either or waking up at 4:30 a.m. but with a new baby boy that arrived (a month early) last Sunday, I better get used to it!

François Trahan of Trahan Macro Research is one of the best market strategists who is an expert in macro and relating it back to sector positioning.

I've known him for years and while I love his research and recommend people look into the Macro Specialist Designation to really improve the market knowledge, to me, he's more of a friend and I truly enjoy hanging out with him when he's in town as we chat about everything, not just markets.

Of course, this week, everything centered around my new bundle of joy so I didn't get to catch up with him but heard the CFA event was a big hit.

Now, I'm gong to be honest, a few of my friends were razzing me when I sent them over a gloomy interview François did the last time he was in town and I will be the first to admit, thus far, we have not seen the earnings recession I was waiting for this year or an economic apocalypse.

But it's coming and my fear is that we are headed for the deepest, most prolonged recession since the 1970s.

I know, the Personal Consumption Expenditures (PCE) index, the Fed's preferred inflation indicator, came out today and core PCE — which strips out food and energy — rose 3.9% on the year, the lowest since September 2021 and down from 4.2% in July. 

The Nasdaq and S&P 500 initially popped on the news but stocks are selling off now.

In my opinion, markets are coming around to the view that a soft landing is a pipe dream, a recession is coming and rates are staying higher for longer as energy prices spike and wage inflation picks up steam.

And therein lies the kink.

While I see rates peaking here as incoming data (watch next Friday's jobs report) comes in weaker than expected, allowing the Fed to pause, if wage inflation picks up steam, the Fed will be forced to hike again later on.

The macro backdrop is just terrible and most people don't realize how bad it really is.

Add to this a looming government shutdown and fiscal crisis which Ray Dalio is rightly warning of and you only begin to see how bad it will get:

Let me be clear, we are fast approaching the inflection point where bad macro news hits stocks and other risk assets so now is the time to manage your risk very carefully.

I trade stocks every day, I know the VIX remains below 20, things look fine, but I have this gut feeling something is going to break and the sh*t will hit the fan.

Maybe not this year, if we are lucky, but when it happens, it will be very bad and a lot of people will foolishly buy the dip thinking it's a short-term thing.

Anyways, the next bear market and recession will be deep and long, just remember that, and it will teach a new generation of investors important (life) lessons.

If Trahan is right, you want to ease up on chasing AI stocks to the moon, forget the "Magnificent Seven" and hunker down.

That also means easing up on cyclical shares although energy remains a wild card for me because OPEC is cutting supply and the US strategic petroleum reserves are at historic lows.

What about bonds? Bill Ackman and other hedge funds are shorting long bonds and so far, they've been right, but I think they're in for a big surprise if my worst fears come true.

We shall see, all I know is the next six months will be epic and you need to manage your risk very carefully.

Alright, I got a little guy I want to cuddle and don't want to sound too gloomy here as I want him to enjoy a long, healthy and happy life.

Below, an older RDI Economie interview with François Trahan he did earlier this year (in French).

Next, Joe Terranova, Brenda Vingiello, Jason Snipe, and Steve Weiss join 'Halftime Report' to discuss markets closing the worst month of the year so far, the impact of bond and oil trades on equity markets, and expectations for Q4 corporate earnings.

Lastly, Bill Ackman is known for his bold moves and investment ideas. In this wide-ranging interview, find out where he’s putting money to work now and get his thoughts on the economy, the markets, possible recession and what he thinks the 2024 election means for the future of finance.

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