Topics Covered
- Key Facts
- LABOR MARKET
- STOCK MARKET
- INFLATION
- THE FED
- Stock Investors Better Hope a Recession Has Started
Importantly, Investors are becoming less confident that inflation will decline enough to prevent a recession over the next year, despite new data suggesting the Federal Reserve’s efforts to ease rising prices may be working. Experts warn the risks are only growing as the depressed sentiment drives the stock market deeper into a weeks-long trough.
Key Facts
- The S&P 500 plummeted on Friday to its lowest point since mid-July as the Bureau of Labor Statistics revealed that the unemployment rate increased in August for the first time in seven months, rising to 3.7% from 3.5% in July as fewer Americans were hired and more people began looking for work.
- The data was “good news” for the Fed because it suggests that the economy is slowing down enough that inflation may soon follow suit, according to Bank of America analysts who spoke to clients after the data’s release. However, they also predicted that the economy will enter a “mild recession” later this year as the Fed continues to raise interest rates, potentially pushing millions of Americans into unemployment.
Adam Crisafulli of Vital Knowledge Media asserts that “the Fed isn’t close to declaring victory,” adding that “there’s still more work to do and further tightening to come” and recalling that Fed Chair Jerome Powell stated last week that households and businesses will experience “some pain” in order to cool demand and lower inflation.
In remarks sent by email, economist David Page of AXA Investment Manager warned that the picture might become worse if new data shows that inflation isn’t decreasing and that the Fed will need further evidence of economic conditions softening before fundamentally altering its policies.
- Page predicts that employment growth will slow to 100,000 new jobs per month by the end of this year, which would be the slowest growth since 2020 even if inflation does moderate. This would likely help prevent higher-than-expected interest rate increases.
LABOR MARKET
Firstly, After the economy recovered from the Covid recession, the labor sector remained one of its strongest pillars, but Friday’s employment report may indicate that hiring is starting to slow down. The number of Americans employed or seeking work reportedly reached a record high last month, surpassing the pre-pandemic peak for the first time.
STOCK MARKET
Secondly, The lackluster jobs report was expected to be good news for stocks, but as recession fears grew on Friday, the market swiftly gave back gains. Since its August peak, the S&P 500 has dropped roughly 9%, and this week it has dropped 18%. The S&P 500 will decline by another 8% by year’s end, according to Savita Subramanian of Bank of America. The tech-heavy Nasdaq Composite Index, however, has further descended into a bear market. This year, it has decreased 27%.
INFLATION
Also, According to Luke Tilley and Rhea Thomas, analysts at Wilmington Trust, “the forecast for inflation remains the key concern for investors.” Although gasoline costs have decreased from record highs, they point out that food and rent prices are still persistently high and may make the picture more complicated in the months to come. On September 19, when the Bureau of Labor Statistics releases its consumer price index for August, there will be another significant inflation reading.
THE FED
Clearly, Bond markets increased their belief following Friday’s jobs report that the Fed will raise rates by 50 basis points—and not the worse-than-feared 75 basis points—but the direction of monetary policy is still quite unclear. Powell’s remarks to policymakers on Thursday at a Cato Institute conference may provide insight on the size of the upcoming rate hike on September 21.
Stock Investors Better Hope a Recession Has Started
Surely, A debate has erupted about whether the US economy is experiencing a recession. There is general agreement that a recession is a contraction in real economic activity, but there is disagreement over how severe, pervasive, and protracted the contraction must be to qualify as a recession. Investors should adopt a practical approach, while economists and politicians can argue over theory.
The segment of the business cycle known as recessions removes economic waste and prepares the way for the following growth. Weaker consumer and business borrowers make defaults, and stronger borrowers limit their expenditures, which reduces debt. Projects and concepts that fail are written off, and money is no longer lost in financial black holes. Bubbles burst. Frauds are exposed and dealt with harshly. Workers reposition themselves for future economic growth by moving, retraining, and in other ways. Business operations reorient to the most promising regions. Businesses that are no longer relevant disappear, making room for innovations.
Recessions should be welcomed by long-term equities investors, as painful as they are for people and businesses. On average, seven months pass before the start of a recession after the stock market peaks. Prices have dropped more than 20% since the latest equities top, which was November 2021 on an inflation-adjusted basis. If a recession is deemed to exist now, it most likely began in January 2022. Is it better for investors if the economy enters a recession in the first half of 2022 or if it continues to grow?
According to the National Bureau of Economic Research, the average length of the last 30 US recessions was 10 months, during which time the real total return on equities was negative 21%. This is based on equity falls of more than 20% that were followed by recessions in less than four months. Bull market periods with an average total real return of 135% were then followed by these. By the ensuing market top, an investor who purchased at the peak just before the recession would have earned 85% more after inflation.
For investors, equity drops of over 20% without a recession within four months were substantially worse. First, stocks remained below their prior top for an average of 13 months. A typical 20-month recession came after that. The average stock loss was only slightly higher than the average for the first batch of decreases (down 26% versus down 21%), but the rebound that followed was far less robust (plus 72% versus plus 135%). As a result, the peak-to-peak real total return was 85% when 20% equities drops were swiftly followed by recessions, as opposed to only 27% when the 20% decline was not.
Although I am unable to demonstrate this with thorough analysis or data, one obvious explanation for the pattern is that attempts to prolong and lessen the agony of recessions result in them lasting longer and clearing out less. Because the Federal Reserve maintained interest rates so low for so long and the government implemented so many stimulus measures, it’s possible that we are not currently in a recession. While they can ease the burden on people and businesses and delay the onset of the recession, they may ultimately result in greater suffering and less gain.
The second straightforward explanation is that supply chain problems, difficulties with the reopening, and high energy and commodity costs as a result of the conflict in Ukraine will result in negative GDP growth in 2022.
Despite the fact that we experienced two consecutive quarters of negative GDP growth, which is a common definition of a recession, it is possible that these events were caused by exogenous problems that only affected a small portion of the economy rather than an endogenous cascade of excessive debt and misallocated resources across the entire economy. In that instance, the 20% drop in the stock market may have been a response to a supply-side shock rather than a sign of impending recession. Before the following recession, the stock market may reach a new high.
Unfortunately, I can’t discover any examples of that later story in history. Although it might be accurate, the US economy doesn’t appear to have experienced it at any point in the last 150 years. Stock market declines followed by swift, brief, shallow recessions, and robust post-recession expansions are two scenarios that we know commonly occur, as are stock market falls followed by sluggish, protracted, deep recessions and weak post-recession expansions. Investors should wish that we are in a recession if those are the only two options.
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• Mohamed El-Erian on Why Stocks Stopped Focusing on Fundamentals in July
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This article does not necessarily represent the viewpoint of Bloomberg LP and its owners or the editorial board.
At AQR Capital Management, Aaron Brown served as managing director and director of financial market research. He may have a stake in the subjects he talks about because he is the author of “The Poker Face of Wall Street.”