The Big Economic Risk Wall Street Isn’t Talking About Stephanie Pomboy

Stephanie Pomboy digs around to find risks and opportunities where
others fail to tread.

Right now, the founder and president of the economic research firm
MacroMavens are forecasting a profits recession, marked by a “huge
margin squeeze for the average corporation.”

It will be a significant price squeeze not experienced since the
1970s, as she tells ThinkAdvisor in an interview.

Gutsy and prescient, in 2002 the economic analyst predicted the
housing bubble’s imminent inflation long before others saw it. In
2007, she foresaw the worst financial crisis since the Great

Last year, Pomboy warned of a stock market crash.

Her profits recession forecast is based on fact: Input costs have been
“outpacing the ability [of corporations] to pass them on,” she argues.

Indeed, “the relationship between input costs and consumer prices is
so integral to the outlook for the stock market,” she says.

Pomboy contends that the Federal Reserve’s monetary and fiscal
stimulus during the worst of the coronavirus pandemic did little to
increase economic activity but instead, did much to create “a massive
bubble in financial assets,” which now, as a result of the stimulus
withdrawal, is starting to deflate, she says.

In the interview, Pomboy, whose clients include investment firms,
mutual funds, and hedge funds, among others in and out of financial
services, maintains that today’s primary risk is that the Federal
Reserve will “belatedly ransack inflation.”

Diving beneath the surface of existing trends, she analyzes economic
and financial market data to find and interpret subtle signals for

That is, she seeks what’s not priced into the market, then forecasts
the implications.

Pomboy launched MacroMavens 20 years ago after a decade of working
with Ed Hyman at C.J. Lawrence and ISI Group. She picked up an
economics degree from Dartmouth College in 1990.

She produces two weekly reports covering risks and opportunities, one
for institutional investors, and the other for retail investors.

Her podcast is “The Super Terrific Happy Hour” (“business, finance,
and economics, with a side-order of skepticism”), which she cohosts
with Grant Williams.

ThinkAdvisor interviewed Pomboy on May 17. She was speaking by phone
from her base in West Palm Beach, Florida.

She noted that no one else seems to be forecasting a profits recession
because Wall Street “take[s] whatever the companies say as gospel
until they say otherwise. No one is looking ahead.”

Here are highlights of our interview:

THINKADVISOR: What are you discerning from your analysis of the
economy and financial markets?

STEPHANIE POMBOY: There’s the very real prospect of a profits
recession. Yet nowhere on Wall Street is anyone forecasting this. It
seems to me it’s a no-brainer.

The relationship between [corporate] input costs and consumer prices
is so integral to the outlook for the stock market.

And right now, the input costs have been far outpacing the ability of
[corporations] to pass them on.

What are the implications?

I’m looking at the difference between the two and seeing an implied
margin squeeze for the average corporation. We’ve never seen a squeeze
this huge other than in the 1970s.

I’m talking about real pressure on corporate profit margins.

Will there be indications of a profits recession on current earnings reports?

Just because input costs are going up faster than corporations’
ability to pass [them] along, doesn’t mean this immediately hits
current earnings reports. It takes a while for it to show up in the
actual earnings numbers.

So it will take time for the commentary from companies to filter into
Wall Street strategists’ forecasts.

Why is no one else forecasting a profits recession, as you say?

No one is looking ahead. They just take whatever the companies say as
gospel until they say otherwise.

Wall Street focuses only on what the companies say. They wait for them
to say [for example], “Here’s our guide for the next quarter.”

What’s the primary risk that you perceive?

The Fed is going to belatedly ransack inflation. This is the main
thing that has the stock market anxious.

You’ll see the stock market continue to come under pressure if the Fed
continues to move rates up.

Most people are saying, “They’ll raise rates, and the economy will
have this, sort of, soft landing. It will slow, and everything will be

I think that expectation is just fantastical, to put it nicely.

Can the Fed trigger a recession by raising interest rates?

It remains to be seen whether we’re in a recession right now or not.
In the first quarter [real GDP growth fell at a rate of 1.4%].

If we do that again in the second quarter, even by the barest margins,
technically we will have accomplished the definition of a recession.

The Fed got religion about inflation right when it was about to take
care of itself anyway because consumers already ran out of the money
with which to sustain their spending on everything at higher prices.

It’s kind of a classic Fed blunder.

What’s the economy’s state of health?

The idea that the Fed can raise rates without precipitating a
recession is rooted in a misapprehension about how strong the economy
really was, to begin with.

When you take out the amount of money that was handed to consumers to
spend, a different picture [emerges] about the inherent strength of
the economy and the ability to withstand the stimulus withdrawal.

But the consensus has been that the economy is strong. How do you
reconcile that with what you’re saying?

One of the things the Fed and Wall Street have underestimated is the
degree to which the strength of the economy that we saw in the last
couple of years was entirely a function of the monetary and fiscal
stimulus, which totaled roughly $10 trillion.

We put $10 trillion into the economy, but GDP grew only $2.3 trillion.
With inflation, you come up with $600 billion in real growth.

It’s sad how little actual increase in economic activity we got for
all that stimulus.

What we did get was a massive bubble in financial assets, which is now
starting to deflate because we’re taking the stimulus away.

You write that the asset bubble is now deflating and “we can expect
spending to slow materially, squeezing margins and depressing hiring.”
Please elaborate on consumer spending.

For so long, real wealth and “phantom wealth” have been the
tail-wagging dog of the economy. When there’s a positive wealth
effect, consumers ramp up spending and have a higher tolerance for
accepting higher prices.

[Just so], when the reverse happens and their net worth starts to
decline, they pull back on spending and on their willingness to abide
by higher prices across the board.

And this is happening now?

We’re getting into that situation now, in part, because policy
suggests that energy prices, for sure, and food prices, maybe to a
lesser extent, are going to remain elevated.

So even as people start seeing their 401(k)s going in the wrong
direction and have the impulse to cut back their spending, they’re
still going to be paying more and more for everything they can’t live

Please discuss what you see happening in the consumer discretionary
space and what it means.

Earnings there is the weakest growth of any of the S&P sectors right now.

People have already drawn down a lot of their surplus savings. They’re
now below what they were pre-pandemic. So they’ve ramped up their
credit cards, which at 16% interest, no one is doing because they want

How serious is this scenario?

People are already searching their sofa cushions for change so they
can keep up with the rising cost of living. That’s going to require
them to essentially cut back on everything they don’t need anymore.

So you’re seeing more discretionary [spending] starting to go away.
And I think you’ll see a lot more of that.

Please characterize consumer spending behavior overall.

Since the last batch of stimulus checks went out in March, we’ve seen
consumer credit card borrowing do a complete U-turn.

Consumers were paying down credit card debt with their COVID stimulus
all the way through. But when the checks stopped, they started ramping
up credit card balances.

At the same time, they started depleting all the savings they had
built up during the COVID bonanza.

Personal savings is actually below what it was before the pandemic. So
consumers are resorting to what I would describe as desperate measures
to keep up with the rising cost of the basic necessities of life.

Still, many unemployed people have chosen not to go back to work.
Please explain.

That’s starting to unwind. We might see a real increase in labor force
participation. We had that situation with the housing bubble in
2005-2007 when there was a huge exodus out of the workforce as
household net worth went up.

People took early retirement; but when the bubble burst, they ended up
going back to work.

You anticipate a profits recession. In view of that, will jobs be as
plentiful as they have been?

Profit margins are the number one input into hiring plans. You don’t
run out and expand your workforce if your profits are under pressure.

What impact will the Fed’s shrinking its balance sheet has on the stock market?

It will have a very meaningful negative impact as well as the earnings
story, which is a shoe that hasn’t yet dropped.

Expectations are for 10% earnings growth this year, and a recession is
a forecast.

So there’s a lot of risk to the downside of the stock market.

How far will it go?

That depends on whether [Fed Chair Jerome] Powell stands back and lets
the market collapse, or if he says, “We’ve got to dial back our
rhetoric” because the impact of a stock market bubble bust would be to
put the economy in a recession anyway.

It’s going to come down to how much pain the Fed is willing to take.

I would suspect that they aren’t going to take a whole lot of pain,
mostly because they’re very skillfully using jaw-boning to great

Meaning that they mainly just keep talking about interest rate increases?

Yes. It has saved them from having to do a lot of actual rate hikes.
They’ve barely raised interest rates, but the market has built-in
massive rate hikes.

So they managed to get that accomplished without having to turn the
screws very much.

What effect do you think the midterm elections will have on this picture?

As we get closer to November, I would imagine the tolerance for any
real pain in the stock market, which would blow back to the economy,
will diminish dramatically.

I think that Powell is feeling emboldened to tackle inflation because
the administration said [essentially], “The inflation problem is our
Number One political liability. We want you to do what you have to do
to nip it in the bud.”

But if we get to September and the stock market is down 40%, they
might decide that [inflation] isn’t as important as our reining in the
financial markets.

What else is informing your view about risk?

The chart of long-term bond yields. Every time we get a little bit
north of 3% on the 10-year Treasury, not surprisingly, things get
pretty squirrely in the stock market.

So I think the threshold for interest-rate pain is far below what most
investors perceive it to be.

You write about a shortfall in pension plan funding. What are the implications?

After the global financial crisis, the Fed recommended that
[investors] start stretching for yield and that they become a little
more aggressive in risk-taking if they wanted to get anything
resembling a decent return.

What did that mean to pension plans?

It was really a problem for [managers]. They had these other-worldly
mandates where they were supposed to generate 8-plus percent annual
return on their pensions.

So [they] had no choice but to hold their noses and buy everything you
wouldn’t want to touch with a 10-foot pole, like junk bonds and
levered loans.

When they ran out of those, they got into quote-unquote alternative
investments, which are apparently in some other universe where 8%
returns grow on trees.

Essentially, these ended up being highly levered and risky.

What will happen with the pension plans if and when the risk bubble bursts?

The people that are going to get left holding the bag are the pension
funds because they were the marginal buyers of all the most toxic

But [since] the Fed bailed out Wall Street after the global financial
crisis, there’s no way they can’t bail out Main Street after the
pension bubble bursts — especially since it will have been their
fault, to put it bluntly, that the pensions ended up in this horrible

Do you think they’ll have to bail them out?

The Fed is going to have to go back to its usual bag of tricks and
support the market if only to make the pensions hold so they don’t
have to bail out $10 trillion in pension liabilities that are
unfunded, which will require them to re-up quantitative easing and
expand the Fed’s balance sheet anew.

The odds that we see a Fed balance sheet at $16 trillion are much
higher than a Fed balance sheet at $7 trillion.

Are there any investment opportunities at all that you see in the market?

When you get into a risk-off period like we’ve been in for the last
few weeks, even things that you’d think would act defensively, like
gold, have been, sort of, cast aside, presumably because right now
everyone is trying to reduce their exposure across the board.

They’re unwinding leverage and taking down exposures, and that
requires basically selling everything.

So you see nothing to invest in that might generate something positive
down the road?

You have a little air pocket where the best you can do is hope to
outperform on a relative basis, like being long on defensive things,
like gold or oil.

I would even say some emerging markets will hold up. They’ll get hit less.

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