Commentators continue to shout the doom-and-gloom forecasts of a hard landing recession, but after an economic hurricane in 2022 there are some signs the financial clouds have begun to lift this year. The stock market has reflected this positive fundamental shift during January, as the S&P 500 catapulted +6.2%, NASDAQ +10.8%, and the Dow Jones Industrial Average +2.8%.
Last year, a major influencing cause to the -19% downdraft in the stock market (S&P 500) was due to the highest inflation readings experienced in four decades, compounded by a Federal Reserve hell-bent on slamming on the interest rate brakes. A big contributing factor to the surge in inflation was the spike in consumer spending fueled by trillions in government stimulus, coupled with widespread shortages in goods triggered by supply chain disruptions.
Fortunately, the headwinds of inflation now appear to be abating. Recently released inflation figures showed core inflation dropping from a peak of 9.1% last year to 3.5% in the fourth quarter (see chart below). Although the Fed will likely raise its interest rate target by 0.25% up to 4.75% this week, the downward reversal in inflation has raised the probabilities of the Federal Reserve “pausing” or “pivoting” on the direction of previous rate hikes. The odds of a halt or cut in rates will likely only increase if the descending trajectory of inflation persists and other upcoming economic data weaken further.
Source: Calafia Beach Pundit
No Signs of Recession…Yet. Investors Waiting for Another Flood
While the calls for a hard economic landing remain, healthy GDP growth (+2.9% in Q4), generationally low unemployment (3.5%), and relatively stable earnings (see chart below) all point to a stable economy with the ability to navigate a soft landing. China’s new reopeningof the economy and Europe’s seeming ability of dodging a recession provide additional evidence for a soft landing scenario.
As you can see further from the 25-year earnings chart above, the drop in S&P 500 earnings in recent months has been fairly modest compared to previous downturns, and the forecast for 2023 earnings is currently estimating a modest gain on a year-over-year basis. Over the last 25 years, we have arguably experienced three 100-year floods (2000 Tech Bubble, 2008 Financial Crisis, and 2020 COVID pandemic), so investors have been bracing for another enormous financial hurricane.
Although the bursting of the 2000 Tech Bubble had an outsized impact on the technology sector, the effect on the overall economy was more muted, as you can observe from the shallow decline in the earnings. As the earnings show, during the Financial Crisis (2008) and COVID (2020), the crash in earnings was much more severe. Thus far in 2023, there has been no earnings plummet or sign of recession, and if financial conditions continue to soften, there is no reason we couldn’t undergo a more vanilla, garden-variety recession like we did in 1990 and 2000.
Stairs & Elevators
While the future always remains unclear, nobody knows for certain whether a recession will occur this year or if the 2022 bear market will endure into 2023. However, as you can notice below, history over the last 70 years shows the duration of bull markets (average of about 6 years) are much longer than bear markets (approximately 1 year). I like to compare bull markets to walking up stairs in a tall building, and bear markets to going down an elevator. The main difference is that the stock market elevator generally never goes to the bottom floor and the stairs keep growing to record heights over the long-run. Since World War II, Americans have experienced 13 economic recessions (see also Recession or Mental Depression?). Not only are investors batting 1,000% in successfully surviving these recessions, they have thrived. From 1956 until the present, the S&P 500 has vaulted approximately 80-fold.
Source: Clearnomics and Standard & Poor's
Presently, economic skies might not all be clear, blue, and sunny, but the fact that inflation is dropping, our economy is still growing, labor markets remain healthy, China has reopened for business, and Europe hasn’t cratered all leave room for optimism. It may not be time to bust out the sunscreen quite yet, but the dark economic clouds of 2022 appear to be lifting slowly.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
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