Michael Burry's Latest Warning For The 2022 Recession

It's no secret that in 2022 the stock market hasn't been a particularly nice place to be. The S&P 500 is down about 20%, the NASDAQ is down 27%, and from everything we've seen in the news lately, it doesn't look like it's getting much better anytime soon. Just last week, we got an update that the annual inflation rate in the US has now hit 9.1%, with a month-over-month rise of 1.3%.

Remember, the FED aims for the annual inflation rate to be 2% per year, so we've got about eight months' worth of inflation in just 30 days. If you delve into the numbers, a huge chunk of that inflation is due to the energy crisis we're currently going through, thanks to Russia's invasion of Ukraine and also the world's subsequent management of that situation. Energy was by far the worst category in June, up 7.5% month over month.

Broken down further, we can see energy commodities up 10.4%, gasoline up 11.2%, and utility gas, or piped gas, up 8.2%. So, big, big increases, and unsurprisingly, the results of this accelerating inflation are big interest rate hikes. The FED is really gearing up now; their next meeting is scheduled for right about the time that this video goes out on the 26th and 27th of July. Economists are expecting at least another 0.75% rise in the federal funds rate, with some even tipping a whole percentage point rise.

The unfortunate reality of the situation is that these interest rate rises will keep happening until that inflation rate is back down to the FED's target of 2% annually. So, there still could be a lot more to come. But of course, what these rate rises mean in reality is that economic conditions continue to get more and more difficult for citizens and businesses.

So, consumers have less disposable income as debt payments rise and life's essentials get more and more expensive. For businesses, this means lower profits at a time when their debt repayments and other costs are also rising. For these reasons, many are predicting that a nasty recession is just around the corner for America, and one person who saw all this coming is the man, the myth, the legend, Michael Barry.

Despite predicting all this at the start of last year, he's recently come out suggesting that in his opinion, we're only halfway there. It already feels like a recession: a trillion in market cap negative multiplier. Now, I've made a few Michael Barry videos lately, and honestly, I've already covered his thoughts on the market crash and the inflation crisis, so I will just leave a link to that video up on the screen now.

In this video, I do want to focus on the reasoning why he thinks we're only halfway there. He recently tweeted, "Adjusted for inflation, 2022 first half S&P 500 down 25-26% and NASDAQ down 34-35%, Bitcoin down 64-65%. That was multiple compression. Next up earnings compression, so maybe halfway there."

This is a pretty insane prediction because it means Barry is thinking we're probably going to get down to an S&P 500 value of roughly 2,800, but it's also pretty scary because I kind of agree with his reasoning. So, what is he talking about? Well, in that tweet, he brings up two factors that contribute to the price of a stock falling: there's multiple compression and then there's earnings compression.

Firstly, multiple compression: what Barry thinks we've seen thus far. What does this mean? Well, of course, the most common and simplistic valuation metric that exists is the price to earnings ratio—stock price divided by earnings per share. If your company owns one dollar per share in a year and the stock price is twenty dollars, you have a P/E ratio of 20.

But we can also rearrange this equation to look like this: stock price equals earnings multiplied by the P/E ratio, or now in other words, the earnings multiple. What multiple of earnings are investors willing to pay for the stock? Now that earnings multiple is very much dependent on what investors think the company is likely to do going forward.

So big growth opportunities, great performance ahead; investors will give it a high earnings multiple. Whereas problems with the company, competition stealing market share, you'll get a much lower multiple. What it tells you is investor sentiment—what investors are expecting to happen in the future. Now, we can apply this formula to a specific stock, but we can also apply it to the market as a whole.

A massive shout out to Roman at PensionCraft, who made a great video on this topic and displayed multiple compression in a really clever way. Really great video, so I'll definitely leave that linked in the description; I definitely recommend you check it out. But what Roman showed is the price of the S&P 500 and the earnings on the same chart to create a joy and a gloom scale.

Let's have a look. This is the air quotes price of the S&P 500 since 1960, and then let's have a look at the earnings over that same time period. From those two lines, we can determine what multiple was put on the S&P 500 during those periods—price over earnings.

For analysis sake, we're going to show that line compared to the benchmark of 15.97, which is the average multiple for the S&P 500 over the ultra long term. Sometimes, investors are overly optimistic and give the market a higher multiple, and then sometimes they're more pessimistic and they give it a lower than average multiple.

As you can see, it goes through cycles where investors are overly optimistic, and then they become pessimistic. Also, just as a side note, you might be asking why there was such optimism in late 2008; that seems a bit weird. Well, actually, that's a special case where the earnings were actually so extremely low during the Great Recession.

However, at the time, prices were being somewhat stabilized because the FED had announced a massive bailout plan. So you get this weird patch at the GFC where prices actually looked elevated versus earnings. But generally, as you can see, the market goes through patches of optimism and pessimism around the average multiple of 16.

And as you can see, running into 2022, that multiple is falling way back towards the average. In fact, this data stops at the start of this year, and as earnings have stayed strong so far this year, yet the market has continued to fall. This line is continuing downward through 2022.

This is what Michael Barry notes as multiple compression. Really, it's a fancy way of saying investor confidence is deteriorating. Last year, investors were willing to pay upwards of 35 times the earnings of the S&P 500 to own it; now, current estimates are that multiple is falling to about 20. So optimism quickly turning to pessimism; thus the market is falling—that's the main takeaway.

It's also affected as well by interest rates; when interest rates rise, new bonds look more enticing, and the big money in the market starts flowing out of the stock market back into the bond market, which drags down the stock market. This is the opposite of what we've been seeing happen over the last few years. You know, interest rates have been very low, and in those times, the stock market usually gets artificially inflated because bond returns are basically zero.

Thus, the big money looks to put their money elsewhere. But long story short, that's multiple compression: investor confidence fading and rates rising. That's the first half of Barry's tweet. But as he suggested, here's his opinion that we're only halfway there. From here, he thinks it's earnings compression that takes over.

So instead of prices being brought down by investor confidence waning, it's also going to be brought down by companies in Corporate America earning less. This goes back to what we were saying before—you know, right now, because inflation is so crushingly high, interest rates are going up.

What that means is that consumers have less spare cash. Have a look at what Barry's been posting lately—he posted this image showing the U.S. consumer savings as a percentage of GDP. What we're seeing right now is people's savings covering less and less of America's GDP at a time when GDP is going down.

He tweeted, "U.S. personal savings filter 2013 levels; the savings rate to 2008 levels while revolving credit card debt grew at a record-setting pace, back to pre-COVID peak despite all those trillions of cash dropped in their laps: looming consumer recession and more earnings trouble."

So what he's getting at is, unfortunately, all this inflation and all these interest rate hikes are leaving consumers with very little in their pocket. Less spending also means less revenue for businesses. Couple that with higher costs and increasing costs of debts, and all of a sudden you’ve got corporate earnings really struggling.

One company that we saw struggling in Q1 that Barry specifically made an example of was Amazon. If we turn over to Simply Wall Street, we can see under the future growth tab that Amazon's earnings were doing alright, but they tanked in Q1. Consumers aren't willing to spend as much, and also, while I don't put very much weight on analysts' expectations, have a look—the analysts are expecting that dip to continue through 2023 and start recovering in 2024.

So you can see the macroeconomics in the numbers. Since 2021, the operating expenses have been increasing at a faster than normal rate, and the cash flow from operations has reduced. Very interesting charts, and if you wanted to have a play on Simply Wall Street, then there's a link down in the description of this video if you wanted to sign up.

It's 100% free to use if you just wanted to try it, but alternatively, if you did want access to the full suite like what I'm using in the video, you can get a 30% discount when you sign up with that link. And as always, thank you very much to Simply Wall Street for their support.

But overall, that is the second part of Barry's tweet. Now that we're seeing significant interest rate hikes and the average consumer is struggling, Barry thinks that from here, we're going to start to see the earnings of Corporate America falling.

Remember, from our equation: price equals earnings times multiple, or investor sentiment. So far, earnings have stayed pretty strong, but the sentiment has fallen. Now Barry is expecting the macroeconomic environment to start seriously impacting earnings, bringing down the share market even further.

Because remember, rate hikes won't stop until inflation is backed down where it needs to be, and so far, we're a long way from that. In fact, at the moment, we're getting further away each month. So that's what Michael Barry is anticipating over the next little while.

Yes, it's a little bit worrying, but remember it's nothing to panic about. You know, these cycles are normal, and we as investors need to be long-term minded to see them as opportunities. The other thing to remember is that not every company is affected equally.

You know, we were just talking about the market as a whole, but there are a lot of companies that don't have any debts, or their business isn't generally impacted during a recession, or they have pricing power. So even though they are battling recession conditions, their earnings can still actually rise.

There are these companies that may still shed some market cap with the rest of the market that might actually be really solid long-term opportunities in these conditions.

So while recessions suck and we as consumers definitely feel the pinch, remember you as an investor can still set yourself up to beat inflation and build your wealth. It's not always as doom and gloom as the media makes it out to be, and really, a lot of fortunes are created in the deepest, darkest recessions.

So overall, guys, that is it for this video. Thank you very much for watching. Leave a like on the video if you did enjoy it and subscribe if you'd like to see more. But, guys, that is it from me. Thanks very much for watching. I'll see you guys in the next one.