Inflation is soaring, the stock market is collapsing and consumers are increasingly worried about their future. None of this is good, but it’s probably time to put the brakes on a little fearing that everything will fall apart. Fears of a recession are definitely on the rise, especially after the US has already recorded a quarter of negative economic growth after GDP fell 1.4% in the first quarter. All it takes is one more to send the economy into the empirical definition of a recession. But the job market is alive and well. Companies are filling over half a million vacancies on average per month in 2022, wages are rising but not as fast as the cost of living and companies are still making money at a healthy pace, recording a gain first-quarter earnings growth of 9.1%, according to FactSet estimates. It is still the problem of inflation that worries the markets the most. The good news is that once it starts to slow, it could increase investor and consumer confidence. The bad news is that it could take a while, like years. This is partly because many factors are influencing the fastest price growth in over 40 years. There are the residual effects of massive fiscal and monetary stimulus, pandemic-related supply chain backlogs, and risks associated with the war in Ukraine. “Economically, you have to keep asking yourself whether there’s a realistic possibility of a recession in the United States. To me, the answer is ‘no,'” said Jim Paulsen, chief strategist for investments at The Leuhold Group. “All these separate fears are one fear. It’s all about inflation, that’s the key here.” Whether 8.3% inflation and accompanying Federal Reserve interest rate hikes are enough to bring the economy to its knees is currently the subject of intense debate. Most Wall Street economists are raising their recession expectations, with Goldman Sachs predicting about a 1 in 3 chance and Deutsche Bank, on the other hand, forecasting a strong period of negative growth starting in late 2023. A reliable barometer on New York Fed data comparing 10-year and 3-month Treasury yields indicated a recession probability of just 3.7% at the end of April. Ed Hyman, chairman of Evercore ISI, said recently that he thinks inflation has peaked, and hedge fund titan David Tepper of Appaloosa Management recently told CNBC he was withdrawing his short position in the Nasdaq, whose voters are most sensitive to higher interest rates. Inflation persistence, however, is scaring investors enough to send the tech-focused Nasdaq into a bear market and the S&P 500 and Dow Jones Industrial Average not far behind. “The market is technically driven and trying to find a bottom. We need to see the capitulation, but there are these technicals that keep breaking,” Paulsen said. Paulsen sees a better fundamental picture than the technicals indicate, mainly due to the strength of household and corporate balance sheets. He is also in camp, along with JPMorgan strategist Marko Kolanovic and others, to see inflation as having peaked in March. Household debt has risen steadily over the past year, peaking with an 8% increase in the fourth quarter to bring the total to nearly $16 trillion. However, as a share of disposable income, it is only about 9.4%, half a percentage point lower than it was before the pandemic, according to Federal Reserve data. Corporate debt to GDP is also lower than it was pre-Covid. Paulsen said investors should focus on long-term strength and invest accordingly. It points to frontier markets, emerging markets excluding China, and the All Country Index excluding the US MSCI as places that could outperform the S&P 500. One way to play the markets frontiers is to use the iShares MSCI Frontier and Select EM ETFs. Ex-China play is through the Columbia EM Core ex-China ETF. Trying to thread the needle… Finding both safety and outperformance is a difficult chore with the cross-currents the market is facing. The approach of Scott Knapp, chief market strategist at CUNA Mutual Group, tries to thread that needle by betting on a better future while facing the realities of the present. In Knapp’s baseline “hard landing” scenario, the Fed must tighten aggressively to bring inflation back to its 2% target and, in doing so, dampen growth and inflict more pain on the market. However, it leaves room for a non-negligible likelihood that inflation will react more quickly to interest rate hikes and require less Fed tightening. “The change of [inflation] expectations cause markets to rally which will likely happen before people know it. A rally like that will get less respect than most rallies,” he said, describing the latter scenario. “People won’t believe it until it’s in their rear view mirror.” such, Knapp recommends a portfolio in which investors take more time risk, something counterintuitive to an inflation scenario.At the same time, investors should keep a solid allocation to commodities, but not overweight.”Investors need to think like options traders, rather than relying on forecasts that are unreliable,” he said. “We need to assess the odds and invest accordingly on the entire spectrum, while maintaining hedges against extreme events on the left. That’s what options traders do, and they don’t rely on trying to predict the future.” “…With a pair of boxing gloves” Those whose job it is to look up The future sees a potentially bleak picture Taming inflation without crushing growth, and history suggests it’s a difficult task, but not impossible Long-lived assets have hit all-time lows dating back to 1978 Inflation expectations for next year remained mired at 5.4% and 3% for the next five to 10 years, both levels well above where the Fed feels comfortable. I’m trying to thread the needle with a pair of boxing gloves,” said Joseph Brusuelas, chief US economist at RSM. “We are in a very difficult situation here, where if they organize a slowdown to 1% [GDP growth] they will cause a growth recession as they claim victory. It’s a tough picture here.” Indeed, the repercussions are being felt in many parts of the economy. The Cass Freight Index for April showed a 0.6% drop in April volumes after rising by 0.5% in March, and the accompanying narrative with the survey was “After a nearly two-year cycle of increasing freight volumes, the freight cycle has turned sharply downhill,” the report said. “The prospect of a freight recession is now considerable, as the substitution of spending on goods for services picks up the pace, and as inflation slows overall spending, particularly via rising fuel prices and making raise interest rates. Interestingly, Deutsche Bank, which has the most pessimistic forecasts on the street, praised Fed Chairman Jerome Powell and his fellow central bankers for following the right course on inflation, even with the consequences “He and his [Federal Open Market Committee] my colleagues know that from the painful experience of the 1970s and early 1980s, the sooner the inflation problem is fixed, the lower the cost will be and the sooner the economy will return to a more desirable growth path the bank said in a note to customers. “The road ahead will not be easy, but the Fed is on the right track.”
Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., May 13, 2022.
Brendan Mcdermid | Reuters
Inflation is soaring, the stock market is crashing and consumers are increasingly worried about their future. None of this is good, but it’s probably time to put the brakes on a little fearing that everything will fall apart.
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