The Recession Question

Despite a week-long stock market rally, financial news media headlines are preoccupied by the recession question. In an interview yesterday, Home Depot co-founder Ken Langone said, “Intellectually and mentally we’re in a recession right now.” That may be. Certainly the mood is sour and we could end up talking ourselves into an economic contraction.

US economic growth—as measured by gross domestic product—fell negative during the first quarter. And according to the Atlanta Federal Reserve Bank second quarter growth is tracking to a mere .25%. That’s perilously close the widely accepted definition of a recession: two consecutive quarters of contraction. Most investment strategists think recession can’t come until next year because consumer & business spending is currently strong and the job market is very tight. But it is possible that we’re already technically experiencing a mild recession. Ritholtz Wealth CEO Josh Brown says that in this case, the majority of Americans wouldn’t “have their lives materially altered…and if we lose a bunch of executives at Netflix but we manage to keep very high employment among nurses, truckers, people working in oil fields, it’s really not that horrible.”

Regardless of whether that box has been checked, the typical process of cyclical downturn seems to be moving more quickly than usual. Certainly Target and Wal-Mart were caught completely off guard by the speed at which consumers shifted spending from goods to services earlier this year. Investors have been amazed at how quickly speculative risk (i.e. crypto & IPOs) has been wrung out of the stock market. Obviously increased risk stemming from high inflation necessitated a reset in market valuations. But Bloomberg analyst Gina Martin Adams says the “correction to valuations is happening three times faster than the bursting of the internet bubble” in the early 2000s. That’s just as well; investors are happy to rush though this painful adjustment period. But it clearly suggests that capital markets are already pricing in recession.

Former hedge fund manager Jim Cramer is emphatic that the answer to the recession question “isn’t available yet.” We agree. Most economic data are still solidly positive (i.e. hiring as well as consumer & business spending). And corporate earnings have thus far been remarkably resilient; yesterday the CEOs of IBM and Nike said they don’t see signs of an oncoming recession. But other reports show parts of the economy are softening (i.e. consumer confidence surveys & home sales). Research firm NPD Group says eight in ten consumers plan to reduce spending in the next three to six months.

This will sound strange, but from an investor standpoint we need to see slower economic activity (i.e. spending, hiring) in the immediate future. Weaker data might convince the Fed that its “hawkish” policy is working to bring down inflation. Said another way, bad news is good because that will set up the economy for a soft landing. If the Fed were to pause interest rate hikes toward the end of the year, my guess is that both stock and bond markets could begin to sustainably recover.

Of course, everything depends on the path of inflation, and slower spending & hiring should help moderate price growth. Certainly, home price growth seems poised to stagnate. And we’re already seeing commodity prices—soy, cotton, sugar, wheat, copper—pull back. On the other hand, oil & natural gas prices remain stubbornly high. For the time being, Hightower’s Stephanie Link says investors are being held hostage by macro-economic data. Every inflation report, every retail sales report, every business activity survey, will be scrutinized by the Fed with an eye to adjusting interest rate hikes. The next major inflation announcement—PCE Deflator—is due later this week, followed in two weeks by the CPI report. We continue to expect increased stock market volatility through this “hostage” period leading up to the Federal Reserve’s nest policy meeting on July 14-15.