America’s Recession Obsession

The financial pages were a veritable compendium of doom on Thursday, as US equities careened deeper into bear market territory amid an escalating recession panic.

For a fleeting moment late Wednesday, markets looked poised for a relief rally predicated on the notion the Fed is finally serious about fighting inflation and, against the odds, might succeed without triggering a deep recession. Or at least that was one narrative. Another story said equities and bonds alike were pleased Jerome Powell doesn’t plan to deploy 75bps increments past the July meeting.

I’d be inclined to suggest that market participants, carbon-based and otherwise, were simply at pains to decide whether Monday’s repricing, especially in front-end rates, was too much, not enough or just enough in the context of Powell’s press conference.

Whatever the case, risk sentiment was very poor on Thursday. Ominous housing data coupled with confirmation that mortgage rates rocketed higher over the last week didn’t help. Neither did another uptick in the four-week moving for initial claims (figure below).

It’s safe to say claims have bottomed. That doesn’t mean they’re going to move sharply higher anytime soon, but the half-century lows reached on several occasions over the past six months were the trough. Almost by definition.

Meanwhile, the Atlanta Fed’s GDPNow tracker is forecasting a recession. Not really, but kind of. Q1’s print was negative, and after Wednesday’s disappointing retail sales data, the nowcast flatlined.

The figure (below) shows the “evolution” — how we went from 1.9% to 2.5%, then all the way down to 0%.

Everyone has their own models. Bloomberg is especially proud of theirs, or at least that’s the impression one gets from the prominent placement it received on Wednesday and Thursday, via a feature story carrying the provocative headline: “US Faces a Fed-Triggered Recession That May Cost Biden a Second Term.”

Do note that the original headline was more mundane. I suppose it works “better” when you bring in politics. After all, we’re living through a highly divisive period in the country’s history and divisive politics sells — just ask Biden’s predecessor, whose odds of returning to the Oval Office probably increase with each passing CPI report. Those odds would rise materially in the event the economy worsens further, notwithstanding myriad unfortunate revelations from the ongoing January 6 hearings on Capitol Hill.

Not that we shouldn’t be honest. My own coverage of America’s inflation battle and the Fed’s belated response has certainly evolved in recognition of the rather stark reality facing the White House and the Eccles Building. In the Bloomberg piece, Nancy Cook, Reade Pickert, Gregory Korte and Anna Wong wrote that,

Voters are telling Democratic pollsters they see economic storms brewing. Key decisions on issues like student loans are paralyzed by inflation fears, according to one person familiar with White House deliberations. The administration is casting around for outside-the box fixes to show they’re fighting for hard-pressed households, from a windfall tax on oil profits to commitments by retailers to cut prices if China tariffs are removed. And its economists are laying out arguments for why the soaring cost of living isn’t Biden’s fault — and the economy is much better than voters seem to think it is.

Efforts to deflect won’t likely be effective. Especially not given the GOP’s penchant for no-holds-barred politics. Bloomberg Economics estimates the odds of a recession by Q1 2024 at 72%.

But what about right now, in 2022? I’ve said this repeatedly, and I’m hardly alone: The US is likely already in a recession. If Q2’s GDP print ends up being negative, the economy will meet the technical definition.

Currently, it doesn’t feel as though policymakers, let alone the White House, are prepared to accept that, which in turn raises questions about whether we’re going to start redefining the term.

Recession is a trending topic among voters (figure above), and incessant media coverage is likely amplifying public angst.

All of this comes before the full impact of recent tightening by the Fed and its global peers has worked its way through to the real economy. Until the last several weeks, the pain was concentrated in asset prices, but as BMO’s Ian Lyngen and Ben Jeffery wrote Thursday, the “impact of wholesale asset price deflation has yet to manifest itself in the wealth effect nor trickle through to consumption.”

Recall that more than half of the $3 trillion hit to household wealth from the equity selloff in Q1 was offset by a $1.7 trillion gain for property prices (figure below).

The shaded grey area shows the breakdown of the “$39 trillion bonanza” mentioned in the subheading.

The first quarter almost surely marked the peak for home values. Going forward, households won’t be insulated from stock selloffs, not to mention historically poor returns in fixed income.

With the Fed committed to hiking rates into restrictive territory by year-end, it’s entirely possible that 2023 could be much worse for the real economy than 2022, even if asset prices begin to anticipate policy easing as the economy rolls over.

“The window for a soft-landing for the global economy is very quickly closing,” Lyngen and Jeffery went on to say, adding that “it would be an understatement to suggest it’s going to be a challenging few quarters ahead.”

Challenging indeed. Considering the distinct possibility that the US economy is in the process of meeting the technical definition of a recession this quarter, one can’t help but ponder whether the country is in for a shallow recession followed by a much deeper downturn. Not a “double-dip,” but rather an ongoing descent into stagflationary purgatory.

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4 thoughts on “America’s Recession Obsession

  1. I haven’t yet seen an insightful analysis of what S&P 500 earnings could be in a stagflation/recession scenario. As of December 2019, the S&P 500 TTM earnings were just under $140 and at all time record highs. After an initial hit in the early pandemic, subsequent TTM earnings grew dramatically to just under $198 as of 4Q21. As of June 2022, it appears the most recent forward earnings forecast was almost $240. How much of these increases were simply a result of temporary pandemic stimulus?

    Even in their recession scenarios, analysts are projected downside earnings significantly higher than the pre-pandemic record level of $140. With a strong dollar, inflated corporate costs, these earning forecasts seem significantly overly optimistic to me.

    1. I’ve mentioned this before. My first cut suggests 2023 consensus EBIT for the SP500 is at least 18% too high.

      That’s a revert to 2019 growth and margins scenario, which is not terribly bearish, in my opinion. 2019 was a pretty decent year, kind of late cycle but downturn hadn’t emerged yet. Be more bearish, and the cut looks bigger.

      However, I haven’t done or seen an explicit stagflation scenario. The 1970s were so long ago, I don’t know that we really know how today’s companies, industries, sectors will respond. For ex, back then the big consumer brands were thought to have pricing power (Gillette, P&G, etc) but today there are so many store brands and Amazon Basics and consumers are less wedded to “Tide” or “Charmin”, that I’m not sure the pricing power is still there. Needs a lot more thought than I, at least, have been able to devote.

  2. Giving credence to analyst’s or politicians projections about company earnings and profits and market projections and now recessions?
    Eventually, with enough predictions, you will be right some of the time.
    But weeding out the wrong ones, well….!
    And those PhDs/economist/experts at the Fed who called inflation transitory? But will now, belatedly, get inflation under control? And engineer a soft landing? Pinch me, I must be dreaming!

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