June 30, 2022

Signs of a recession pile up… will the Fed chicken out when faced with the hard decision?… why a recession is better for your portfolio than the alternative

To have a recession or not have a recession, that is the question.

Well, it’s not exactly our choice. And no one wakes up wanting to have a recession.

That said, it might be our best option today.

It certainly might be preferable to the alternative course of action: the Fed chickening out on rate hikes, which risks keeping the economy and stock market in an insufferable sideways grind.

Let’s begin our discussion with why a recession is appearing more likely.

***Joynese Speller landed a new job as a project-delivery specialist at the beginning of the month

On the Friday before her start day (the coming Monday), she got an email.

Due to logistical problems, they wanted to push the start day to Tuesday.

Well, that slid to Wednesday, then Thursday.

Finally, on Friday came unexpected news…

Her new job had been eliminated due to budget cuts.

Speller isn’t alone. CNBC ran an article last week titled “People are having their job offers rescinded days before they start.”

We’re beginning to see a tightening jobs market across the board. A few weeks ago in the Digest, we noted how layoffs in the venture-capital tech sector are picking up steam.

From that Digest:

The site Layoffs.fyi has been tracking tech startup job losses since the pandemic started, and it's starting to show a marked increase in layoffs in the last few months.

In May the site tracked 16,935 jobs lost, the highest monthly reading for 24 months, only behind the ~26,000 tech startup jobs that were lost during the early months of the pandemic.

Over in the crypto sector, companies announced more than 1,700 layoffs in June alone. These cuts have come from Gemini, Crypto.com, BlockFi, and Coinbase, among others.

And it’s not just tech-focused VC and crypto jobs.

Last week, we learned that JPMorgan Chase is laying off more than 1,000 mortgage workers, Netflix is laying off 300 employees, and Tesla will lay off 3.5% of its total workforce.

Meanwhile, two weeks ago, cosmetics company Revlon filed for Chapter 11 bankruptcy protection, making it the first household consumer-facing name to do so in months. And CNBC reports: “The retail industry is up against a potential wave of bankruptcies following a monthslong slowdown in restructuring activity.”

***When we check in on the U.S. consumer, we find that cracks are forming there, too

This morning, we learned that headline inflation remained at 6.3%, same as in April. That’s slightly under March’s reading of 6.6%, which was the highest level since January 1982.

Equally important was what this morning’s report told us about personal disposable income — it fell 3.3% from a year ago. And spending adjusted for inflation fell 0.4%, which was down sharply from the 0.3% gain in April.

From Bill Adams, chief economist at Comerica Bank:

The rising cost of living absorbed all of the increased spending power from added jobs and higher wages in May.

Americans are running faster just to stay even. No wonder consumer confidence is in the pits.

Much has been made about the strong condition of the U.S. consumer, but the personal-savings rate, which is the amount of disposable income that people save, was just 4.4% in April. That clocked in as the lowest rate recorded since September 2008.

This morning, we learned it edged up slightly in May to 5.4%, but even that level remains one of the lowest readings in more than a decade.

From The Street:

The number of people without any savings is currently the highest in 12 years of polling…

"The percentage of Americans who are comfortable with their emergency savings has gone from 54% to 42% in the past two years, while those uncomfortable has jumped from 44% to a majority 58%," Bankrate's Chief Financial Analyst Greg McBride said in a statement.

"Inflation at the highest levels in 40 years will erode the comfort level with, and buying power of, your emergency savings."

As we saw a moment ago, this is translating into a U.S. consumer who is beginning to spend less.

From Bloomberg:

A key source of US economic growth this year — consumer spending — is showing signs of losing steam…

Credit card data show that spending in May was just 10% higher from the same month last year, according to a Barclays report this week. For the rest of 2021, that monthly spending growth has averaged more like 20%. 

And this is from the Washington Post:

Retail sales slowed last month for the first time this year, driven by a 4 percent drop in car sales. U.S. flight bookings dipped 2.3 percent in May from a month earlier, according to data from Adobe Analytics.

And both high- and low-income Americans have begun pulling back, particularly on services, in the past four to six weeks, according to an analysis of credit card data by Barclays…

Spending on services like travel and restaurants, which was growing more than 30 percent from 2021 rates this year, has now slowed to half that pace, according to the Barclays analysis.

***On Monday, we received another big nod toward a recession from the Dallas Federal Reserve, this time on the manufacturing front

The monthly Texas Manufacturing Outlook Survey showed a steep deceleration of factory activity.

From MarketWatch:

Manufacturing activity in Texas contracted in June for the second straight month and factory output grew only marginally, according to a survey from the Federal Reserve Bank of Dallas released Monday.

The production index of the Texas Manufacturing Outlook Survey—a key measure of state manufacturing conditions—decreased to 2.3 in June from 18.8 in May, suggesting that manufacturing output barely expanded over the month.

The index for general business activity—which assesses broader business conditions—fell to minus 17.7 from minus 7.3 the previous month, the lowest level since May 2020 and signaling that activity declined as the reading came in well below the zero threshold which separates expansion from contraction.

Why is this a big deal?

Well, Texas represents about 9% of the entire U.S. GDP.

Plus, this is likely foreshadowing what’s happening with broader manufacturing throughout the nation. We’ll get more on that in tomorrow’s release of the ISM Manufacturing Report.

***Put all of this together, and it appears we’re cruising toward a recession

It’s not guaranteed to happen, but we’re certainly headed in that direction.

But here’s the reality — whether we get an official recession or we skirt it and barely escape, we’re in for some degree of pain. I mean, it’s already started. Who isn’t feeling more pinched today?

After all, between the trillions of dollars the Fed flooded into the economy, its slow response to transitory inflation, and endless supply-chain problems, the damage is baked in.

The only issue now is whether we deal with the consequences decisively in order to get it over with, or drag it out, lengthening the pain.

Your portfolio is hoping for the decisive response.

***Will the Fed chicken out with its rate hikes?

That’s what some analysts and money managers believe.

They claim that the amount of public and private debt is simply too astronomical to handle the interest rate hike needed to snuff out inflation.

For example, here’s Rick Rule, former president and CEO of investment fund Sprott U.S. Holdings, focusing on the damage to public companies:

If we had a period of real interest rates it would certainly cure inflation, but it wouldn't cure inflation until it did amazing damage to various balance sheets.

Despite the doubters, Federal Reserve Chairman Jerome Powell is talking a big game.

From Powell, speaking yesterday:

Is there a risk we would go too far? Certainly, there’s a risk.

The bigger mistake to make—let’s put it that way—would be to fail to restore price stability…

I agree with Powell.

Not restoring price stability leaves us with an awful “in the middle scenario,” in which inflation isn’t out of control, but it’s high enough to significantly erode Main Street wallets.

Meanwhile, interest rates aren’t at Paul Volcker levels, but they’re high enough to be a weight on economic growth.

The “take your medicine” alternative is to hike rates enough to kill inflation, even if a recession is the collateral damage.

As investors, we should prefer this because the sooner we walk through the pain, the sooner the markets start climbing in anticipation of a genuine economic recovery.

***The timing mismatch between the economy and your portfolio

The economy and the stock market don’t operate on the same timeframe.

Wall Street is always forward-looking. Because of this, when there are economic storm clouds on the horizon, the pain starts earlier for stocks.

But the flip side is equally true — the pain ends earlier.

Here’s Forbes with the top-line of how this works:

So, how do stocks perform when the economy is faced with a recession?

The S&P 500 surprisingly rose an average of 1% during all recession periods since 1945. That’s because markets usually top out before the start of recessions and bottom out before their conclusion.

In other words, the worst is over for stocks before it’s over for the rest of the economy.

In almost every case, the S&P 500 has bottomed out roughly four months before the end of a recession. The index typically hits a high seven months before the start of a recession.

Now, if stocks turn the corner before the economy, then would buying quality stocks during a recession be a wise move?

That’s what history tells us.

Here’s Sam Stovall, chief investment strategist at CFRA Research, with some blunt timing advice on this note:

Prices lead fundamentals—therefore the stock market falling into a decline is traditionally an indication that most investors believe we are headed for a recession.

When we do finally fall into a recession, that’s usually a good time to get back into the market.

But this buying opportunity can’t materialize (or, at least, it will take much longer to materialize) if the Fed doesn’t have the guts to address inflation in a decisive way that, frankly, puts the economy second.

So, what’s going to happen?

We’ll get the next installment of the saga on July 27th, when the Fed concludes its next policy meeting.

Odd as it may sound, let’s hope for a big hike.

Have a good evening,

Jeff Remsburg