Stocks staged a late-session rally last Friday as investors jumped in, not wanting to miss an impending rally. Investors are becoming increasingly concerned that a recession may become a reality in the future…the rest is up to the Fed.
Can’t feel a thing. What is a recession anyway? The National Bureau of Economic Research (NBER) is the agency tasked with officially declaring a recession. I am sure that they do other things in between, but when you read about the US being in a recession, it is up to those folks to make it official. Though it is not simple to make the declaration, the agency’s high-level requirements are vert straight forward: a recession occurs when the US undergoes 2 successive quarters of negative Real GDP growth. There you go. Did you know that in the first quarter of this year we experienced negative GDP growth? Sure you did, because you read my market note every day. In fact, the economy contracted by -1.6% in the first quarter of the year. If we observe the details of Q1 GDP, we note that Private Investment grew by +5%, down significantly from the +36.7% and +12.4% increases in the final 2 quarters of 2021. Private Investment captures spending made by businesses. Imports shot up by +18.9% representing a surge in shipments made after bottlenecks began to ease. Imports have a negative impact on GDP because capital is flowing out of the economy. Exports declined by -4.8% for the quarter which was likely the result of the war in Ukraine and the stronger dollar which makes US goods more costly to foreigners. That too has a negative impact on GDP because there is less capital flowing into the economy. Now finally we have one of my favorite topics, consumption. You know, all the goods and services consumed by me and you. That makes up more than 2/3 of GDP. In Q1, Consumer Spending rose by +1.8%. The good news is that it grew, given its strong impact on overall GDP, however, it was down from earlier quarters. When you add it all up (and Government Spending, which I intentionally omitted) you get a -1.6% decline in GDP growth for the quarter.
Knowing what NBER officially refers to as a recession and knowing that we now have 1 negative-growth quarter in the bag, you are probably a bit more concerned that the quarter that ended just last Thursday (Q2) may come in with a negative growth as well, making recession official. Don’t worry, you are not alone in your concern. It is on everyone’s mind these days, as is clearly evidenced by the markets in recent weeks. Slipping bond yields, increased volatility, and the lowering of expectations for rate hikes are signs that investors are attempting to forecast an economic downturn in the future. Of course, it is still not clear when, or even if we will enter a recession, however the probability seems to be on the increase. Let’s take a quick look at last week's economic releases for some clues.
We started the week with a Durable Goods orders number that actually exceeded economists’ estimates. Durable Goods are big ticket items that, as one famous economist once noted, can hurt your foot if dropped. The real definition is something that will have use for 3 years or more. Examples of durable goods are wash machines, televisions, cars, and the like. While durable goods were on the climb in May, we may experience a decline in the coming months as many of those items are purchased using credit, which is getting increasingly more expensive, thanks to rate hikes. We need to watch this one carefully.
Conference Board Consumer Confidence was also released that week and it came in at 98.7 for June after logging a 103.2 in May. That simply shows us that consumer confidence waned from May to June. In fact, that number started 2022 at 115.2, but it was even higher (128.2) at the end of 2019, just prior to the pandemic. This is a critical one to watch because, as noted above, consumer behavior has a major impact on GDP, and lack of confidence always portends a pullback in spending.
Last week, we also got a timely ISM Manufacturing PMI for June which showed a decline to 53.0 from 56.1 in June. We have been keenly focused on the Services component in the past few years as it was hardest hit in the pandemic, but that does not mean manufacturing is unimportant. It, in fact is, and a pullback in that super-sector is a sign of a slowing economy. Another one to watch closely.
Finally, we got the Federal Reserve’s favorite inflation indicator, the PCE Deflator. PCE stands for Personal Consumption Expenditures and the index is a close cousin of the more widely quoted Consumer Price Index (CPI). The fact that the Fed watches it more closely means that we should too, if we want to get an idea of what the central bankers’ next move may be. That number came in lower than expected with a +0.3% month over month change bringing it to +4.7% year over year. That is lower than the prior read of +4.9%. While that is still far above the Fed’s +2.0% target, its slight decline may indicate that inflation may be easing, albeit slowly. This could be the result of a decrease in confidence, decreased consumption, or both. Regardless, that is precisely what the Fed is hoping to achieve with its rate hikes, and it may mean that the Fed will be able to slow its rate hiking pace.
All of these numbers together, positive and negative have been absorbed by the markets, and the verdict seems to be: recession may be coming, recession may already be here, and the Fed will possibly be forced to slow or stop hiking later this year. The big question that remains is how the equity markets will actualize that verdict. Will bad news for the economy be good news for stocks, or the opposite. One thing is for sure, investors need to stay on their toes in coming weeks as more and more numbers roll in representing the final part of Q2 and, of course, the corporate earnings season for Q2. Oh yeah, we also have an FOMC meeting coming up later this month. So much for sitting back and enjoying the summer sun.
LAST FRIDAY’S MARKETS
Markets rallied last Friday to start off the second quarter. Hopes that the Fed will slow down its rate hiking later this year have investors breathing a sigh of relief. The S&P500 climbed by +1.06%, the Dow Jones Industrial Average rose by +1.05%, the Nasdaq Composite Index gained +0.90%, and the Russell 2000 Index advanced by +1.16%. Bonds gained and 10-year Treasury Note yields pulled back by -13 basis points to 2.88%. Cryptos climbed by +3.00% and Bitcoin added +3.61%.
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