Reflections on a Rolling Recession
What happened last week?
- The S&P 500 lost 2.3%
- The Dow Jones shed 1.1%
- The Nasdaq composite fell by 2.8%
3 Things to Know
Don’t Wait for Something Worse
From the US Federal Reserve’s perspective, the rolling recession scenario provides time for their potent monetary tightening medicine to work.
Friday’s July nonfarm payroll report posted data that showed US employment posted the first back-to-back monthly gains of less than 200,000 in the expansion thus far. This suggests that the post-COVID stretch of “labor market outperformance” is finally waning.
US labor markets gains will likely stall in the year to come while industrial activity bottoms and begins recovery.
Yet, we do not see a rapid rise in unemployment on the horizon, but rather a cooling that takes labor market gains to a crawl by early 2024.
When that scenario occurs, the Fed’s focus will shift, and rates will come down to support the economy.
Data Supports a Recovery
This economic scenario suggests that we will see higher short-term rates for longer, and a slower rate of interest rate declines until the Fed begins to feel that supporting the economy and jobs is more important than slaying “rear-view mirror” inflation.
From an investors point of view, this “glide path” to 2024 is positive. If investors wisely move from cash to bonds, they should be able to lock in high real interest rates.
For equities, this is a time for value consciousness. The NASDAQ and S&P Index tech leaders have driven the valuations of those indices to high levels quickly, mostly on the “AI Craze” that caused just seven stocks to add nearly half of the gain to global equities this year.
But that masks the relative values of mid-cap growth and international equities that are trading as if no recovery in 2024 was on the horizon.
Our strategy, therefore, is to invest in the equity and bond markets that reflects high relative value. At some point, when bond markets normalize, a more significant tilt towards equities overall is likely. But during this transitional time, core “60/40” portfolios may do fine.
The data from 1931 and 1969 provide ample evidence that when the most unusual circumstances occur — like the joint declines of stocks and bonds in a given calendar year, consolidation and growth in markets becomes more likely, not less.
Fitch Downgrade = No Impact
Ratings agency Fitch downgraded the US credit rating from AAA to AA+ in early August. The timing is a little confusing as the US has passed through its semiannual debt ceiling gauntlet and spending has fallen dramatically after the pandemic spike.
Currently, high interest rates make financing the debt more challenging, but we see no non-political reasons the US would ever default on its debt.
The last time the US was downgraded markets had fully digested the news within a week and it was then back to business as usual.
Our view is that this scenario is likely to repeat itself.
See our weekly CIO Strategy Bulletin for more details