The Normal Cycle in the Non Normal Cycle

There has been alot of talk recently about inflation and even the Fed pulling back some of the liquidity they have added to the market. Hence, the ideas of a V shaped recovery are popular.

I think it is all ridiculous. I don't think the odds of a depression have really dropped off that meaningfully in the last four months and in some ways I think the playbook for a depression is being followed fairly closely.

In my latest quarterly letter I talked about the normal cycle within a non normal cycle. I said:

Modern economic history in the last hundred years has been split into two basic cycles. The “normal cycle” which ends with a Fed induced recession caused by raising interest rates, forcing the economy to slow with the overall goal of keeping a lid on inflation and the “non-normal” cycle which is the result of too much leverage in the system outside of the Fed’s control. This is what occurred during the Great Depression and Japan’s implosion in the 1990s. It is incredible that investors are still trying to apply the economics of normal cycles to the current economic decline. The world is in a “non-normal” mega deleveraging cycle. Of all the premises circulating in the marketplace, this appears the most obvious.

and

As production stabilizes, investor’s optimism rises, but investors are looking for the normal cycle. In reality, it is the normal cycle embedded in a non-normal cycle, the production stabilizing after inventories are worked off, but the underlying demand is still deteriorating. A stabilization in overall production occurred in late 1930 into early 1931. There was great hope that the bottom was in; yet, demand was still deteriorating. This demand stabilization is what matters (not production or inventory levels) and investors are once again failing to recognize the difference between today and normal recessions.....If the deleverging continues, which seems inevitable, demand will continue to decrease. If this decrease continues, once the inventory correction is complete, the production will once again turn lower. It is what occurred in late 1930 and unless the deleverging stops, it will occur again.

What is occurring is what I wrote about. We have had two months in a row of retail sales dropping, both months missing forecast. We are almost assured now a third month in a row (May). That should mean consumer spending was down in Q2 after a bounce in Q1. Today same store sales were reported. Chain store sales were down a record 4.6% in May.

We probably have another month of two for production to catch up to the depletion in inventory but what matters is the demand stabilization. There sill appears to be little of that occurring. This means the normal road of a depression / non normal cycle is being followed very closely.