The Detox Period
While Jay Powell and the Federal Reserve met this week for their latest FOMC meeting, little has changed in HAI’s overall outlook. Financial assets (despite being short-term oversold) appear extremely vulnerable to further significant downside price action, while gold (albeit temporarily overbought) seems to be basking in the glow of strengthening fundamental tailwinds.
On March 7th, speaking on CNBC’s “Squawk Box,” Treasury Secretary Scott Bessent warned of an expected “detox” period for the economy as new policies from the Trump administration attempt a dramatic course-correct from a decades-long unsustainable path. Bessent said, “Could we be seeing this economy that we inherited starting to roll a bit? Sure. And look, there’s going to be a natural adjustment as we move away from public spending to private spending. The market and the economy have just become hooked. We’ve become addicted to this government spending, and there’s going to be a detox period.”
Last Sunday on Meet the Press, Bessent added that the Trump administration is laser-focused on preventing a financial crisis that would have been “guaranteed” under the previous conditions of massive government deficit spending. As Bessent put it, “What I could guarantee [emphasis added] is we would have had a financial crisis. I’ve studied it, I’ve taught it, and if we had kept up at these spending levels—everything was unsustainable.” He then added, “We are resetting, and we are putting things on a sustainable path.”
Now, HAI doesn’t know exactly what this administration will attempt to do and exactly how it will attempt to do it. However, this author is confident that the U.S. economy cannot be detoxed from past reliance on excessive government spending and set on a sustainable fiscal path without triggering significant withdrawal symptoms. Simply put, such a profound detox necessitates far too much sudden change to avoid the resulting—and likely profound—shakes.
That said, make no mistake, Bessent is exactly right—the unsustainability is real, and the detox is necessary. We have debt-to-GDP of over 120%, deficits-to-GDP already at a crisis-like 7%, and, as of last week’s latest Treasury update for February, we have “true interest expense” (interest expense plus entitlements) running at a fiscal year-to-date rate (starting in October) of 108%—even with tax receipts at all-time highs. In other words, given the tab for just interest expense and entitlements, the U.S. could entirely cut defense spending and every other line item (an impossibility) and still fail to balance the budget.
To be clear, when a sovereign state cannot cover interest and interest-like obligations out of tax receipts, it has an acute fiscal problem on its hands. The new administration undoubtedly grasps that fact, and HAI commends this administration for boldly staring truth in the face. But HAI wants to be similarly bold in communicating to readers the potential near-term negative economic and market implications of attempting to tackle such a massive and unsustainable structural problem—even if ultimately necessary.
If in this detox period Bessent and DOGE don’t even aim to balance the budget, but instead just reduce deficits-to-GDP from 7% to 3% (as is Bessent’s stated intention), the estimated hit to GDP from that reduction in government spending is expected to be a whopping negative 5%.
Given that the Altlanta Fed GDPNow real-time GDP tracker for Q1 2025 has already been bouncing around in negative territory, that potential pending negative 5% GDP hit implies a future U.S. recession. And, importantly, recall that in the last three U.S. recessions, the deficit-to-GDP has always increased by at least 6%.
In other words, government spending cuts (given our late-stage fiscal crisis with a dependence on government spending to spur GDP growth) could now be causing a recession that, in turn, will reduce tax receipts, blow out deficits-to-GDP even further, and (perversely) accelerate debt spiral dynamics that materially undermine the U.S. bond market and, by extension, U.S. financial assets broadly.
Crucially, recent economic data warns that the weakening trend may be in the process of becoming entrenched. The administration’s efforts to telegraph dramatic spending cuts, tell public workers that massive job cuts are coming soon, and tell U.S. companies that big tariffs are on the way, all seem to be translating into significant belt-tightening by both consumers and businesses due to a massive spike in future economic uncertainty.
In other words, Bessent’s detox period may have begun, and it might turn out to be much more toxic than the administration and markets currently assume.
According to the latest Conference Board Consumer Confidence Survey data, “vacations intended” have just crashed to the lowest levels since 1978 outside of only the 1980 recession, the 2008 Great Financial Crisis (GFC), and the Covid lockdown of the global economy.
Similarly concerning, the latest University of Michigan percent of consumers expecting business conditions to weaken over the year ahead just reached the highest level since the 1980 recession. UMich data also confirmed that the number of consumers expecting the labor market to deteriorate (a figure historically highly correlated to future unemployment in data back to 1978) just hit an extreme high level only seen in past recessions. Furthermore, the latest ADP small business payroll growth data has now accelerated a new downturn into contractional territory as well.
Also this week, in its interim outlook, the Organization for Economic Cooperation and Development (OECD) confirmed U.S. consumer and business jitters by estimating that President Trump’s tariff hikes will drag down growth in Canada, Mexico, and the United States while driving up inflation. The OECD also warned that in an escalating trade war, not only would economic growth slip further, but U.S. households would pay a high direct price. It further projected that the economic slowdown will cost the United States more than the extra income the tariffs are supposed to generate.
Those OECD stagflationary concerns were seemingly validated this week by the latest data from the New York Fed’s Empire State Manufacturing Index, which showed that factory activity in New York State plummeted this month by the most in nearly two years (down nearly 26 points to negative 20 from a positive 5.7 in February), with new orders (a leading indicator) also falling sharply while input prices climbed at the fastest rate in more than two years.
Additionally, on Tuesday this week, the Labor Department’s Bureau of Labor Statistics reported that U.S. import prices (which exclude tariffs) increased 0.4% last month (significantly higher than consensus estimates for a 0.1% decline), matching January’s disappointing upwardly revised gain. Needless to say, the unexpectedly steep rise in import prices amid higher costs for consumer goods does not bode well for the inflation outlook.
Returning to this week’s Fed meeting, that stagflationary threat of slowing growth accompanied by higher prices was also a theme directionally endorsed by the FOMC on Wednesday. The latest Fed Summary of Economic Projections (SEP) upgraded the 2025 outlook for PCE inflation from 2.5% to 2.7% while simultaneously downgrading the outlook for real GDP growth to 1.7% from 2.1% previously.
Now, if Bessent’s detox period has indeed begun, the Fed could be directionally correct in its increasingly stagflationary projections while significantly overestimating growth. That said, the Fed’s updated SEP dot plots reinforce the idea that investors should expect significant near-term pain from ambitious administration policy maneuvers before hoping to reap the potential benefits of any longer-term gain.
Again, in HAI’s view, financial assets (despite being short-term oversold) appear extremely vulnerable to further significant downside price action, while gold (albeit temporarily overbought) seems to be basking in the glow of strengthening fundamental tailwinds from the gold positive implications of a very wide array of potential outcomes.
Given a macro set-up that currently seems to dramatically favor the outlook for gold over that of bubbled-up and overvalued financial assets, it’s interesting to note that, currently, the 20 largest U.S. and Canadian gold mining companies offer a superior free cash flow yield compared to that of the 20 largest U.S. and Canadian tech stocks. This is the first time since 2001 that gold mining stocks have appeared this attractive from a valuation and free cash flow yield perspective relative to the tech sector bubble-market leaders of recent decades.
At present, it may be rewarding to remember that 2001 also marked the very beginning of what would prove to be a roaring bull-market for gold miners and one of the industry’s strongest-ever decades of relative share price outperformance. In HAI’s view, given the expected implications of Bessent’s detox period, at present, history certainly looks set-up and well prepped to repeat.
Weekly performance: The S&P 500 was up 0.51%. Gold was up 1.26%, silver was off 2.22%, platinum dropped 3.24%, and palladium was off 0.99%. The HUI gold miners index was up by 2.74%. The IFRA iShares US Infrastructure ETF was down 0.49%. Energy commodities were volatile and mixed on the week. WTI crude oil was up 1.64%, while natural gas was off 3.10%. The CRB Commodity Index was up 1.02%. Copper jumped by 4.44%. The Dow Jones US Specialty Real Estate Investment Trust Index gained 0.19%. The Vanguard Utilities ETF was off 0.24%. The dollar index was up 0.42% to close the week at 104.13. The yield on the 10-yr U.S. Treasury was off 6 bps to close at 4.26%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
