The Transition to Growth Risk

Posted by Jacob Radke

Policy risk has plagued 2022 and 2023 will be its undoing. We are transitioning into a period of growth risk and we will see what effects it has on the economy and a pending recession.

noun: a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

Burdened with Policy Risk

Up to this point we have really only seen in the markets what is known as policy risk. Policy risk refers to the implications of certain policy actions, whether that be the Federal Reserve or Congress, on the economy or financial markets.

Most notably in 2022, we’ve seen this risk in the form of monetary policy. Monetary policy is controlled by the Federal Reserve and what it does is it can raise or lower base interest rates (borrowing costs; the cost of money) and it controls the amount of monetary base, a fancy term for the amount of money in the system.

The Federal Reserve has two mandates, full employment and price stability (inflation). These two seemingly uncorrelated economic variables actually have more in common than you think. During times of full employment price stability starts to become an issue, and during times of unemployment price stability starts to become an issue. The former refers to inflation, and the latter refers to deflation. When you have high unemployment it is a sign that we are living in a recession. Recessions kill demand and lower prices.

But deflation is infinitely worse than inflation, with deflation people are incentivized to wait and spend rather than spending in real-time. Spending is what drives our economy, so if everyone is waiting, we’ve got problems.

Lucky for us we are on the other side of that.

We have full employment and high inflation. The Federal Reserve has to get that under control. That means slowing down the economy and seeing some people getting laid off.

But where are we at in this?

Monetary policy has long and variable lags meaning a 0.25% jump in interest rates may not be felt in parts of the economy for 12 months. We are approaching 12 months from the first interest rate hike in 2022, and we are starting to see the cracks form. But we are also nearly to the end of interest rate hikes from here.

What does that mean?

That means that we are transitioning from speculating on what the implications of monetary policies will do to seeing the implications in real-time.

If you aren't confused yet, let me confuse you. You may want to read this twice.

All year we’ve had the anomaly of good news being bad news and bad news being good news. That is because good news meant that the economy wasn’t slowing. If the economy was still growing fast that meant the Federal Reserve had to raise interest rates higher, calling for more policy risk that sent markets lower.

That is policy risk and it is what defined market uncertainty in 2022.

Transitioning to Growth Risk

Growth risk is different but not by much. With growth risk, the good news is good news and the bad news is bad news. We’ve got a recent case of growth risk playing out to our benefit. That case is 2020.

In 2020 the policy risk wasn’t monetary policy risk, rather it was Congressional policy risk (when would they let us out to fix the economy). That is what sent markets falling.

The growth risk came when they did let us out and we started heading back to work and spending more or less like normal. What happened was companies hired at the fastest pace pretty much ever, and people were able to go to work faster. Every Thursday when the jobless claims data came out, it came out better than expected and the markets rallied.

This the what happens when the market overprices the impact of policy risk and the implications to growth aren’t as bad.

The market rallies.

I’m not so sure we’ve found ourselves in the same situation as in 2020 and coming out of policy risk the market has overpriced the implication of the Federal Reserves tightening.

The market hasn’t likely overpriced the implications of the Federal Reserve, I’m not sure they’ve even accurately priced it. They may have underpriced it.

That means that in 2023 we could have turbulence in markets. It doesn’t mean it’s going to zero or that it’s going to fall another 20% even. It could just mean that we will see not a lot of movement up or down for the first couple of quarters.

But watch out because the markets are always watching ahead. As the worst of the news starts surfacing the market will start looking ahead to brighter futures and that is where you get a new bull market.


Bull Case: Inflation comes down and we get a mild or no recession - it wouldn’t surprise me to see a 15% return on the S&P 500, that not the base case though (its the bull case).

Base Case: Inflation comes down and we get a mild to deeper recession - I could see returns on the S&P 500 being between -5% and 5% (this is what the market has already kind of priced in).

Bear Case: Inflation comes down and we get a deep recession - now this is where I could see the market falling another 10-15% in response.

But let’s go through some long-term bets real quick before I close. Say you have $10k lying around, do you wait and see if things fall another even 5%? I don’t think so. In my bear case, the S&P 500 could fall another 15%, and that $10k would turn into $8.5k, sure that is bad, but what if my bull case happens? That $10k would turn into $11.5k. Now let’s look beyond 2023. Markets have historically always recovered and we have no reason to believe this will be any different. The difference in +/- $1.5k is minuscule in 20 years.

You’re already buying at a discount, it’s what I am doing. If you are truly worried, dollar cost average over the year and smooth out your risk.

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