In this update, I aim to provide some clarity on why a US economic recession has been approaching for what feels like eternity, as well as give an update on our economy and markets.
- If there is a modern-day prophet, it is the treasury bond yield curve, and he has been screaming, “recession coming,” for a while now.
- Corporate earnings are beating analyst expectations! But they are still mostly negative.
- Consumer prices are finally increasing at more reasonable rates, which is very good. However, the Federal Reserve wants to see growth slow in the labor market before letting off the economic brakes.
- We are most likely going to see a 25-basis point (0.25%) rate hike coming from the Federal Reserve later this month.
Analysts agree that the signals are all in place to indicate a recession in the near future. The strongest indicator being the inverted yield curve. The yield curve inversion occurs when the 2-year treasury bond has a higher interest rate than the 10-year treasury yield. As U.S news puts it, “an inverted yield curve has accurately foreshadowed all 10 recessions since 1955.”
The recession has been postponed for a while because the Federal Reserve is trying to reduce inflation by stifling economic growth with one hand, and working with government agencies to prevent economic collapse with the other.
Despite the government’s efforts, there continues to be cracks showing up in other areas of the economy. For example, in addition to the bank failures seen earlier in 2023, corporate bankruptcies have risen to the highest levels in the 1st half of the year since 2010. Late and missed rental payments are on the rise for commercial real estate, especially among small businesses. A Bloomberg report recently explained, “The Top US Bank regulators are asking lenders to work with credit-worthy borrowers that are facing stress in the commercial real estate market.” Finally, despite all the news about companies beating earnings estimates, the reality is that corporate earnings are in decline. Just less so than expected (See exhibit 2). Per a MarketWatch article, “Wall Street expects per-share profit for S&P 500 index companies to fall 6.5% for the second quarter, according to FactSet. That would be the worst decrease since the 31.6% plunge seen during the same quarter in 2020.”
CPI data released on July 12th showed Core CPI trickling down, which is very positive. Core CPI excludes volatile food and energy price changes from Consumer Price Index (CPI) data. It is often seen as a more reliable and consistent measure of inflation for consumer prices.
That being said, the Federal Reserve is most concerned with employment and wage data. Average hourly earnings went up 40 basis points (0.4%) in June (4.4% year-over-year). In addition, the US economy added 209,000 jobs in June and there were still 9,800,000 job openings at the end of May, revealing that there is still work to be done to bring down wage inflation.
What is happening at the Fed?
The Federal Reserve meets on the 25th and 26th of July to set the next iteration of monetary policy. The consensus among investors is that the Fed will raise interest rates by 25 basis points (0.25%), based on Jerome Powell’s (Chairman of the Federal Reserve) rhetoric, and the recent economic data releases. While higher interest rates are likely to exacerbate the likelihood of a recession, the Fed wants to see the labor market and wage growth come down before declaring victory on inflation.
We are on the lookout for a reduction in corporate earnings during Q3/Q4, which could negatively impact the stock market. That being said, even if this occurs, it may not be the case for every sector. All this to say, we are fully invested, but remain on high alert for changes to arise as the coming recession makes its way into the economy.
I hope you enjoyed this update. Please let me know your thoughts by sending me an email at firstname.lastname@example.org.
Disclosure: Statements of future expectations are based on current market conditions, and involve uncertainties that could cause actual results to substantially differ from those expressed. This commentary is for informational purposes only and should not be construed as specific advice.