Markets Pricing In Recession Whether Or Not It Comes

Major stock market averages opened mixed this morning (Dow +91 pts; SPX flat; Nasdaq flat). Gains are led by financials, industrials and materials. On the other hand, the energy sector is down 2% in early trading. Some of the most beaten-down sectors are catching their breath while the best-performing sector lags. Commodities are trading uniformly lower today, but bonds are catching a bid.

Capital markets are clearly anticipating a growth slowdown and perhaps recession. I offer this as evidence: banks, homebuilders and automakers are down 30%-40% from recent peaks; airlines are down over 20% and cruise lines over 40% since the end of April; oil stocks are down 20% in just the last month. This comes despite the fact that demand within all of these industries is currently very healthy. But investors are anticipating a much less robust economy in the next 6-8 months.

Jonathan Golub of Credit Suisse says we can’t possibly have a recession with such a strong job market. Goldman Sachs’ Ronnie Walker agrees, saying we’ll likely skirt recession. As I’ve pointed out in this blog, by its widely accepted definition we are likely already in recession (that is, two consecutive quarters of negative growth). But perhaps my assessment is too simplistic. The National Bureau of Economic Research (NBER) is in independent body charged with identifying recessions. And it is true that economic growth is only one of four major data points they monitor. The others—payrolls, real personal income and real gross domestic income—are still positive according to Mr. Walker.

I see real positives in the macro environment as well, but at this point I don’t think technicalities matter. As I’ve said, capital markets are already pricing-in a minor recession. With consumer sentiment surveys at record lows, it’s safe to say we are all expecting it. Many professional investors think a coming earnings recession is the next shoe to drop. That is, Wall Street projections for corporate earnings growth in the coming year seem too high given all the headwinds (slower consumer demand, strong dollar, high cost inflation, less pricing power). Earnings season kicks off this week, and we hope to get some clarity.