The U.S. economy has seemingly performed an incredible feat in recent years. Even with persistent inflation and rising interest rates weighing on consumers and businesses across the country, and wars in the Middle East and Europe stifling global growth, there is little sign of a U.S. recession.
The crisis phase of the modern business cycle that so many Wall Street forecasters said was inevitable not long ago seems to be gone. And it’s not just the economy that’s flying in the face of this conventional business-cycle wisdom: U.S. stocks have also soared in recent years despite significant headwinds.
Wall Street bulls argue that this is all an unusual but not unprecedented economic “soft landing,” driven by consumers and businesses that are now structurally more resilient to higher borrowing costs. Some even argue that we are living in a period of American economic and market exceptionalism, or a “Roaring 2020s,” due to factors such as the U.S.’s relative energy independence and its exposure to the AI boom.
But for Mark Spitznagel, founder and CIO of private hedge fund Universa Investments, all of these ideas are just attempts to find a story that explains how “this time it’s different,” when the reality is that history tends to repeat itself, or at least rhyme.
“It’s no different this time, and anyone who says that is really not paying attention,” Spitznagel said in an interview with Fortune, and added: “The only difference is the size of this bubble that is bursting is bigger than we’ve ever seen.”
Spitznagel has claimed for years that the Federal Reserve helped blow up the “biggest credit bubble in human history” with years of loose monetary policy. He has warned that all bubbles eventually burst, earning him a reputation as a permanent bear population that he has worked hard to break.
Even now, when most Wall Street pundits have turned bullish this year, the veteran hedge funder is worried about the economy. He believes the negative effects of the Fed’s monetary tightening during a period of high corporate, consumer and government debt have simply been postponed.
According to Spitznagel, recent signs of a slowing economy and a peaking stock market, including rising unemployment, an increasingly cautious consumer and unpredictable market movements, should not be ignored. With his patented strategy, called tail-risk hedging, he tries to profit from sharp market declines.
“This is a typical tightening process, peaking process, inversion process, going into a recession. I would be surprised if we’re not in a recession by the end of this year,” he said.
A ‘powder keg’ economy
Not long ago, many Wall Street forecasters were in Spitznagel’s pessimistic camp, warning of an impending recession. But most no longer see any looming risk of an economic or market crash. After years of predicting impending pain, Bank of America no longer predicts a U.S. recession this year at all, while JPMorgan and Goldman Sachs put the chances of a recession at just 35% and 25%, respectively, over the next 12 months, not far above the historical average of 15%.
Still, Spitznagel, who employs Nassim Taleb, the statistician and academic who popularized the concept of the rare and unexpected event called a “black swan,” as a “distinguished scientific advisor,” dismissed the bullish views on Wall Street. He argues that the current, relatively stable economy is “not inconsistent” with the lagged effects of Fed tightening. “It takes time for the higher cost of debt to work its way into the system,” the hedge funder explained.
We have been stuck in a period where the economy is becoming increasingly expensive due to borrowing, but that will soon come to an end.
Why? Spitznagel says the Fed built a “tinderbox” economy by keeping interest rates near zero and stimulating the economy with quantitative easing, a policy of buying mortgage-backed securities and U.S. Treasuries for as long as it could. That policy created an environment where businesses and consumers borrowed heavily to invest and spend because it was cheap, he says, which led to high debt levels and artificially perpetuated unsustainable business models.
To make his point, U.S. nonfinancial corporations currently held a record $13.7 trillion in debt in the first quarter of this year, according to Fed data. And total global debt also hit a record $315 trillion in the first quarter, according to the Institute of International Finance. Much of that debt is government debt, but Spitznagel worries about the sustainability of that too.
The U.S. national debt surpassed $35.1 trillion this summer, and the U.S. debt-to-GDP ratio is expected to hit 116 percent in 2034, according to the Congressional Budget Office. That’s higher than what was seen during World War II. The situation appears similar abroad, too.
View this interactive chart on Fortune.com
Rising government debt levels could make it harder to implement new, large-scale economic stimulus programs, slowing economic growth.
With the Fed keeping interest rates high for years, Spitznagel fears the impact of rising debt costs on businesses, consumers, And governments worldwide will soon rear its ugly head. “You can’t close it down to the biggest credit bubble in human history without feeling it,” he said, repeating something that has sounded a bit like his mantra in recent years.
The most important indicator to keep an eye on
The main indicator Spitznagel watches for evidence of an impending recession is the yield curve, which shows the interest rates on bonds, usually U.S. Treasuries, of equal credit quality but different maturities. Historically, when the yield curve inverts, meaning that short-maturity bonds offer more interest than long-maturity bonds, it is an indication that a recession is coming.
Each of the last eight U.S. recessions going back to the 1960s has come after the 10-year Treasury yield fell below the 3-month Treasury yield, for example. And currently, the U.S. 3-month yield has been above the 10-year yield for 22 months, the longest inversion in history.
However, the inversion of this yield curve is not the real recession indicator, Spitznagel says; it is the return to normal, or disinversion. “It is one of the most significant [recession] “There are indicators that the yield curve is no longer inverted. Just look at the historical data,” he said.
Historically, it takes an average of almost a year after the first three-month/10-year yield curve inversion for a recession to begin. But to make Spitznagel’s point, it takes an average of just 66 days from the time the yield curve disinverts before the economy bursts, Reuters first reported, citing data from Jim Bianco, president and macro strategist at Bianco Research.
For the outspoken hedge funder, the current yield curve disinversion trend is a sign that a recession is coming, and likely within a year. “Is the yield curve distance inversion going to be meaningless this time? It’s never happened before,” Spitznagel said. “Is the employment reversal going to be meaningless this time? It’s never happened before.”
Doomed to a stagflationary future
Spitznagel fears that the excessive debt burden of the global economy and the Fed’s “money printing” will lead to a period of low growth and high inflation after the bubble bursts and a recession ensues.
He argues that the Fed will be forced to do “something heroic” to save the economy and markets when they burst, but that will only be a “Pyrrhic victory.” Cutting rates, reviving quantitative easing or even launching new, untested stimulus measures won’t be enough to prevent significant pain for consumers and investors. And when the Fed’s efforts start to have an effect and help stabilize the economy, stagflation will become a problem.
“It will look like a recovery, but there is just so much that [money] “printing can do before it actually undermines growth,” Spitznagel said. “As Friedman wrote in the late 1960s, all money printing is ultimately stagflationary once the printing and inflation are expected.”
“Printing money has never and will never create wealth, so expect gold and commodities to become a real commodity again after the next epic crash,” he added.
While Spitznagel fears that a recession is coming, that the stock market bubble will burst soon and that stagflation is a long-term risk, he also added a caveat to his pessimistic long-term outlook.
“I don’t think we’re headed for the Great Depression. I’m not one to say the end of the world. I just don’t think we’re going to like the things that have to be done to save this artificial, massively manipulated bubble that we’re all living in,” he said.
And finally, Spitznagel, who has been bullish since late 2022, warned that bubbles tend to end on euphoric highs, and he believes the last leg of our current bubble still has room to grow. For investors, this means that shorting the market is a bad idea.
“I’m just trying to clear my conscience here,” he said. “If your readers are shorting the market and they end up having to buy back 20% or more, that’s not my fault. I think a blowoff [to the peak] is coming. It’s going to pinch [bearish investors].”
This story originally appeared on Fortune.com
