Are We Already in a Recession?
June 6, 2022
As recently reported:
- Gross domestic product in the U.S. declined at a 1.4% pace in the first quarter, below analyst expectations of a 1% gain.
- Declines in fixed investment, defense spending and supply-constrained imports weighed on growth as well as high exports and declines in inventories.
- Real Consumer expenditures rose 2.7%, driven by services, but expenditures on physical goods subtracted from growth and prices rose a 7.8% increase in prices.
Most economists wrote this data off as “noise”, pointing to the strong and tight labor market as an indicator of continued demand and strength in our economy. What if it isn’t, though?
It is a very unusual economy right now in which domestic strength may be trumped by incredible supply side shocks coming from China’s COVID surge and Russia’s invasion of Ukraine. Inflation might have started to subside early this year without these shocks, but now goods inflation in the U.S. is spreading to services. Though these pricing pressures may be temporary, we cannot deny that recent data clearly says “Stagflation,” a condition we haven’t seen in decades.
Traditionally, it takes two quarters of negative growth for the National Bureau of Economic Research to call a recession. More recently, they have used other indicators as well to clarify contracting activity in the U.S. Today, the mix of data is confusing. Consumer demand is strong, most wages are increasing, unemployment is low. With all this, though, the Index of Consumer Sentiment is in the low 60s, not far from levels last seen in 2008-2009. Perhaps confidence is telling us something we are not seeing clearly through the confusing data. If this is so, then what?
It might mean that we are already in the start of an economic slowdown. It might be a “soft landing”, or it might be a “recession.” Here, we need to pause and acknowledge that half the U.S. population only knows the word “recession” in the context of the 2008-2009 experience. That was an extreme economic dislocation, seen only three times in the past 100 years. In contrast, the U.S. economy has had many slow-downs and recessions that have reset the economy. In a more typical recession, growth is slowed for a period, markets likely correct, and companies recalibrate their strategies and processes. From there, the economy recovers and grows for the next cycle.
If we are in a slow-down already, the significant rise in interest rates in the bond market has done its job, well ahead of the Federal Reserve. One reason many investors are having such a bad year in their portfolios is that fixed income/bond investments are down as much as equities. These are the investments that are meant to provide safety and ballast in portfolios, but this year these have done as poorly as some growth stocks. Why have bonds done so dreadfully? Because bond traders decided the Federal Reserve was not acting quickly enough to raise the shortest interest rates. In response, investors and traders have pushed interest rates up (and prices down) across all maturities to better reflect the inflation and growth risk that they perceive in the economy. If they are correct, then current fixed income prices now reflect much that may be needed to correct the economy, particularly if we consider that we may already be in a recession. Future Fed rate hikes will merely bring the shortest maturity rate- the Fed Funds rate- in line with the rest of bond maturities already in the bond market.
Second, it might mean that stock valuations have fully corrected as well. We are almost at the end of the first quarter reporting season for earnings, and corporate leaders have reported ongoing pricing pressures, some supply chain challenges, and mostly acceptable demand. The standout in the quarter was Netflix, in which investors seemed stunned that subscriber growth would fall once our children were back in school full-time. The real surprise might have been the valuations that all these stocks achieved during the COVID shut downs, which unwisely reflected unending growth projections for demand that clearly were driven by the pandemic. And yet, the corrections so far this year may have over shot: many stocks have retreated even below pre-pandemic levels, despite solid fundamentals and sustainable opportunities. This is typical at the start of an economic slowdown when the market gets ahead of the economy and sinks to overly pessimistic expectations. If we are already in a recession, many of these stocks are at levels that present a buying opportunity.
From the mid-1960’s until the early 1980’s, the stock market indices were flat as inflation flared and retreated. For reference, they were also flat for a decade from early 2000. The difference is our recent experience had plenty of volatility along the way due to the changing structure and operation of our markets. Still in both these prolonged sideways periods, active investors and those building wealth were able to grow their portfolios. If we are at the start of a prolonged battle with inflation, it does not mean that portfolios will stagnate.
Predictions from economic experts are ranging from healthy 3-3.5% GDP growth to recessions starting in the U.S. this year. There is no consensus from our most trusted sources. I often look at mixed data and see positive trends ahead, and I still see that positive potential. But I am beginning to believe what I see is the recovery from a down-turn that we have already begun.
Please reach out if we can be helpful to you through these uncertain times.