Sven Henrich Spots Comparisons with 2019 and 2007
Most of us remember what happened in 2007. Sven Henrich of NorthmanTrader thinks the same thing may happen again. Is there any sort of real evidence for this?
There are all sorts of articles and views on the stock market, of various qualities. Some articles make more sense than others, but with even the ones that may not make much sense, they can still be a learning experience of sorts for us by thinking them through.
It seems that many people who read about the stock market don’t spend enough effort on thinking, and we therefore can see anywhere from dire prognostications to the use of some very misleading correlations taken much more seriously than they should.
Some things are at least somewhat a matter of debate, where we’re looking to interpret incomplete information, and investing by nature involves less than complete knowledge. Sometimes though we just end up going beyond the debatable and go into the realm of jumping to conclusions and other broken reasoning.
For the many of us that were around both in 2007 and 2019, any comparison between that situation and now as far as the risk of a recession goes should strike us as pretty absurd without even hearing why they are so alike, because we know how fundamentally different that they are. Tidbits such as the Fed cut rates in September in both years and other meaningless trivia aren’t going to be enough to even have us wondering
NorthmanTrader founder and analyst Sven Henrich disagrees, and he’s compiled this and a number of other comparisons to convince us that we may be on the precipice once again. This still leaves us with the task of deciding whether the situation is substantially similar overall, where we look at both what is the same and what is different to arrive at an overall conclusion of the risk.
It wasn’t just that rates were cut in September both times, it was our being told both times that we aren’t headed for a recession that has made such an impression on Henrich it seems.
The Fed is going to cut rates any time it feels the need, and these two recent cuts are actually marginally justifiable at best, as opposed to the kind you make when you are actually in real trouble. The cuts after this crisis certainly weren’t marginal and took several more and several years of being in effect to get us back to even.
The most we could really take from this is that the Fed is not always right, but they are right plenty and we can’t just single out this mistake and conclude that they will be wrong again. This requires a lot bigger sample than one. When we do look at the Fed’s performance since then, the economy being restored to health and being kept there for a decade is plenty testament to their knowing what they are doing often times at least.
The Recession of 2007 Was Not Caused by Commonplace Events
There were more things going on in 2007 besides a September rate cut and a no recession assurance, the sort of things that actually did cause the recession. If the Fed really did understand what was going on well enough, they would have accelerated rate cutting a lot more than they did.
That September, they did cut 50 basis points off of the rate, similar to what they did in late July and September this year in total. In 2007, this had been the first rate cut since 2003, with rates gradually climbing each year since until reaching the 5.25% at the start of September 2007.
As these rate hikes were put in place, we saw GDP growth drop from 3.8% in 2004, to 3.5% in 2005, to 2.9% in 2006, to 1.9% in 2007. By the time September rolled around, we were already on the brink of a recession and later that year we arrived.
We might think that 1.9% GDP growth that we had in 2007 is eerily similar to where we are now, and last year’s GDP number is even identical to what was in 2006 If Henrich was looking to tell a scary ghost story this part should have definitely been included, as it at least has more substance. One of the differences between them, and a big one, is that we are fighting GDP growth around 2% with much lower Fed rates than we did back then, 2.5% lower in fact.
With the loss of momentum in the economy since the Fed started raising rates in 2004, seeing GDP growth cut in half in a declining manner, this should have been a red flag in itself, regardless of whatever else was going on. 2004-07 was not the Fed’s finest moment by any means.
There is no question that putting rates up as much as they did, and leaving them up as long as they did, contributed to the demise that occurred later. When you have all the bad subprime mortgage debt out there that we had, this is the last thing you need, with so many shaky mortgages that depended on rates not going up to avoid default coming up for renewal.
Fingers needed to be pointed at both those who wrote so many mortgages that depended on rates not going up, and the Fed who actually did put them up, from 1% at the beginning of 2004 to 5.25% in 2007. The mortgages were very risky, but this risk came home to roost courtesy of the Fed.
This approach was too hawkish even during normal times, but these weren’t normal times. The Fed of the day went about their business just like things were fairly normal, not fully understanding how much pressure had built up beneath the earth that was about to blow. We cut them then without knowing how much more we would need, and they dropped to zero not that long afterward. We’re cutting them again, but this time there’s no volcano. Cutting rates with and without a volcano is different, very different.
The fact that we’ve cut them again shouldn’t really alarm anyone, but Henrich is also one of those who is preoccupied with treasury rate inversions, and the fact that this hasn’t had any effect is passed off as our “ignoring” it. Plenty of people didn’t ignore it actually, and this did weigh on the markets a fair bit when we got really close, but those who put much stock in this need to understand that correlations in themselves don’t mean much because we need to understand the whole picture and also seek to understand what causal relationships are in play.
Comparing September rate cuts by the Fed during these two years is actually an outstanding example of how a correlation may not be meaningful, and this is a better example than we could even have expected, given how disassociated these events are with a coming recession.
Inversions don’t cause recessions. Inversions are caused by a longer-term bond outperforming a shorter term one. This happens when people just buy more longer-term bonds, and nothing more. Bond traders don’t have a crystal ball to see the future, and a lot of the action with long treasuries lately resulted from people fleeing the terrible yields of bonds from other countries as well as those who wanted to hold USD.
It doesn’t really matter what is causing this though, as we need to look at the big picture in all cases. When we compare situations, such as during an inversion, we may have the inversion in common but there are many other factors at play, and ones that actually do contribute to the risk of a recession, and the inversion isn’t even one of them.
No Matter How Many Things are Similar, It’s Only the Meaningful Things That Count
For the trivia buffs out there, Henrich’s comparisons don’t stop there, as he points out that in both years, we had a rally in July, a sell-off in August, and a rally in September. In order to be entitled to connect the dots here, we do need to establish how these ebbs and flows would somehow reveal or contribute to a recession. This might seem a little eerie but like with eerie movies, the eeriness is just to frighten you, and Henrich is a little frightened it seems.
We didn’t have an inversion in 2007, and both bond yields and inflation were a lot higher than they are today. We had those other things though, but these other things simply are not even that meaningful, let alone persuasive.
Henrich does admit that none of this means that a recession will be coming but “the ingredients are there and all that’s needed is a trigger.” If these curious coincidences are the ingredients, that simply isn’t going to set off or even contribute to any explosions of any real consequence.
Henrich believes that “the confluence of circumstances is impressive.” He goes on to compare the Fed’s remarks in each September and finds some more similarities. It is not enough to have just a confluence though, as the confluence must be both meaningful and predictive.
In both these cases, all we really saw in September was two actions that both involved a rate cut and a belief that not a lot more will be needed. That’s what they believed, but what happened after the 2007 cut was not your ordinary happenings after a rate cut, and we’ve seen plenty of them to not be entitled to assume that this has any real predictive value.
We now need to step back and look at what really happened, and the market did not crash because the Fed cut rates in September of 2007 or their telling us that a recession wasn’t likely, the July rally, the August sell-off, the September rally, or any other events that cannot possibly cause a financial crisis or anything that meaningful.
If we learned anything from the past here, it is just how devastating a massive wave of defaults can be, although we already really knew that, we just got to see it. That is the fundamental difference between the two years, where in one case you have trillions of dollars of toxic debt and in the other you have default rates at historical lows with no real concern on the horizon.
Bad debt caused the crisis that started in 2007, and we had extremely high amounts of that in 2007 and a very low amount now. To back up claims that compare similarities, we can’t leave out the most important step, which is to show a causal relationship of the similarities to the event that we’re looking to predict.
None of Henrich’s oddities measure up to this criterion, or come close, and while this is an interesting comparison, it is interesting for entertainment purposes perhaps, much like Bernanke and Powell wearing the same tie would be. Coincidence doesn’t cause recessions though.
They didn’t wear the same color tie, or there may have been more evidence presented.
Editor, MarketReview.com
Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.
Contact Monica: monica@marketreview.com
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