#recession

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The Q3 Gross Domestic Product (GDP) growth rate of 2.6% was in line with the consensus. But it was anything but normal. The increase was entirely driven by a large increase in the trade balance. Net exports surged 2.8% due to a 1.6% increase in exports of energy commodities and military hardware, and a 1.2% decrease in imports. Inventory liquidation was lower than Q2, giving a boost to GDP.  Consumer spending rose 1%, mostly in services, offsetting a decline in consumer goods purchases. Capital spending creeped up with residential investment falling for the third straight quarter.

The big market reaction to this report came from the GDP price deflator rising just 4.1%, well below the 5.3% expected, and down more than half from 9.0% last quarter. But much of this was the result of a decline in the growth of import prices due to the rising dollar. With the dollar having declined over 4% from its September 28 top, import prices are not likely to repeat their magnified impact on the GDP deflator going forward.

Bottom Line? The report, excluding the trade balance, showed little core growth in Q3 and by itself should not change the Federal Reserve’s (the Fed) thinking/forecasts for 1-2% GDP growth. The main reason the GDP print was strong is because Europe is collapsing into a recession and is now overly reliant on US energy and weapons exports. It also did little to dispel fears that the US will eventually tip into a classical recession given the aggressive steps the Fed is taking to stamp out elevated inflation.

The decline in 10-year bond yields seems to be the ongoing reaction to the Fed in becoming more aware of the liquidity strains the strong dollar has created in global currency markets, anticipating a slowdown in their rapid ascent in the Fed funds rate. Those expectations were boosted by today’s (outlier) decline in the growth of the GDP deflator. The stock market reaction highlighted these events as both energy and industrial stocks are leading the advance.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

Some say it is a chaotic and frustrating time to be an investor. Rising employment and wages and resilient consumer spending are offset by rising inflation driven mostly by volatile commodity markets and supply chain disruptions. Higher corporate earnings estimates are being met by declining price-earnings multiples. And the Russia-Ukraine conflict raises unknown and unknowable geo-political risks. Stock prices inevitably were lower to reflect such a dismal environment.

All the bearish headlines have been overwhelming and lay the foundation for investors to get trapped in “confirmation bias”, the tendency to put more weight on information that supports a pre-existing view. There are many analysts and investors committed to the outlook that the global economy is declining, and stocks are headed for a massive move lower, and the Federal Reserve (the “Fed”) can make it worse.

It goes like this: Since the end of the second World War, the Fed has never successfully engineered a decline in inflation that was running more than 4% that didn’t result in a recession. This was because they had to break either the economy or the financial markets to reverse the previous cycle’s household wealth gains to reduce consumer spending and prices.

But the Fed’s recent public pronouncements about their future intentions, while only raising the Federal Funds rate to a range of .50% -.75% so far, have already forced 10-year bond yields up from 1.5% to 3% this year, causing the worse drop in bond returns since the middle of the 19th century. And most speculative equity positions have been wiped out such as the 78% decline from its high in Cathie Wood’s Ark Innovation Fund (ARKK), and cryptocurrency index fund Bitwise (BITW) falling from $100 to $15. Both the Nasdaq¹ and the Russell 2000² have declined by 30%. The Fed has already broken a lot of things. All of this has tightened financial conditions already.

So, is it highly unlikely that the Fed will push as hard as the market has already discounted? In fact, the Fed’s favorite inflation gauge, the personal consumption deflator (PCE), excluding food and energy, already peaked in February on a year-to-year basis.³ And the worry about surging wages pushing up inflation may be premature, as average hourly earnings have been declining on a year-to-year basis for the past three months.⁴ Existing and new home sales are falling sharply, and housing inventories have risen to a 9-month supply as mortgage rates are near 5%.⁵ Real income growth is negative and anecdotes from Amazon, Walmart and Target suggest retail inventories are close to being fully replenished even as overall consumption growth is decelerating.

All of this suggests a lower glide path for inflation, the size and extent of monetary tightening, and the diminished odds of stocks making a “massive move lower”.

1. The Nasdaq Composite is a capitalization-weighted index that includes almost all stocks listed on the Nasdaq stock exchange and is heavily weighted towards companies in the information technology sector.

2. The Russell 2000 Index is a small-cap stock market index that makes up the smallest 2,000 stocks in the Russell 3000 Index.

3. Source: Bureau of Economic Analysis.

4. Source: Bureau of Labor Statistics and Tradingeconomics.com.

5. Source: National Association of Realtors and Tradingeconomics.com.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results.  It should not be assumed that your BFSG account holdings correspond directly to any comparative indices or categories.

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

The first link in the supply chain, the number of ships backed up in Los Angeles and Long Beach harbors, is in sharp decline as the accompanying chart from BCA shows.

The harder part is relieving the structural scarcity of trucks, drivers, and logistics (i.e., port workers, warehouse capacity) to decompress supply-side inflation. As this is a longer-term problem, even with a slowdown in aggregate demand in the quarters ahead, overall inflation (aside from base effects) is likely to be stuck in the 3-5% zone for some time.

To a large extent, Covid sterilized labor force participation rates, as the willingness and ability to work may have been secularly altered. With birth rates declining and older workers reluctant to return to the labor pool, long term inflation is unlikely to return to the sub-2% pre-pandemic levels. These factors among others will ultimately induce the Federal Reserve (the “Fed”) to alter their inflation target or else risk a policy-induced recession.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Robert Verdugo, CMFC®, APMA®, Financial Analyst

As the Federal Reserve (the Fed) is poised to start raising rates today, and with the S&P 500 (1) down over 10% off its highs, is it time to declare the bull market dead? History would say no – in fact, a resounding no. Jess Menton’s article in Bloomberg, titled “What Happens to Stocks When the Fed Hikes: A Historical Guide”, does a quick dive into the historical performance of the S&P 500 after the first initial rate hike by the Fed.(2)

The previous 8 rate hike cycles all ended with the S&P 500 higher 12 months later, 50% of those instances had the market up after just three months.

The article also highlights the different sectors and their relative performance after the rate hike begins:

It makes sense that the technology sector would be the leader out of the gate, considering it’s typically the sector getting battered prior to the actual rates increase.

While this does argue the case that the bull run may still be intact, could there be a stumbling block (or two) that could make this time different? Absolutely, and it could very well be the reason why you’re gritting your teeth at the pump. According to the article, recent oil price surges may create a problem for the Fed. In the past, oil shocks have “… preceded economic downturns in the mid-1970s, early 1980s and early 1990s. But other recessions, like after 9/11 in 2001 and the global financial crisis in 2008, weren’t directly caused by a sharp rise in crude prices.” A second large reason for more volatility will be midterm elections this year, as they traditionally cause a ruckus for the markets in the preceding months before the elections.

The market is said to be forward looking, and it requires a very accommodating Federal Reserve to signal its moves. While it’s never been a perfect marriage, the stock market does its best to price in future actions in the current market. Is that what is happening during this correction? Only to start its rise after the hikes begins? Nobody knows for certain. What one can safely assume, however, is that more volatility is in store in the near future. Let’s also hope for a less stressful times at the gas station too, that would be nice.

1. The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market.
2. Please remember that past performance may not be indicative of future results.

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.

By:  Thomas Steffanci, PhD, Senior Portfolio Manager

Let’s cut through the ongoing cross currents of Wall Street and other pundits’ chatter about supply chains, the pandemic, the Federal Reserve (the “Fed”), and market volatility to concentrate on the proven drivers of stock market investing.

History attests to the maxim that if you don’t expect a recession nearby, stay invested in stocks. That sounds like a haughty claim, but it turns out to be true. The catch is when do we know a recession is around the corner.

Stock investors have underestimated the role of the business cycle in driving corporate earnings. There is a close and consistent relationship between business cycle indicators and the path of earnings and revenues, and these in turn drive stock prices. The empirical relationships are often dismissed as unnecessary noise to stock pickers until the business cycle spoils their investment plans.

Stock prices usually peak about six to nine months before the onset of a recession; so, if you think the economy is going to stay out of recession for the next 12-18 months, stay invested. In fact, over the past half century, except for the 1987 market crash, there has never been a decline in the S&P 500¹ of more than 20% outside of a recession.

Without recounting the economic and financial imbalances, and errant Fed policy, which led to previous recessions, suffice it to say this: Over-extended housing, capital spending, oil supply restrictions, along with strongly rising inflation expectations sow the seeds of recessions.

We do not believe that is the business cycle environment today. Much of today’s inflation is a function of unconventional supply-chain disruptions, which should ease as the pandemic fades, and the effects of prior fiscal stimulus will also diminish.

Monetary policy tightening cannot address those issues, which is why the Fed will likely take a far more measured approach in this environment, despite consensus handspringing about six or seven rounds of interest rate increases. Consumer survey-based three-year inflation expectations have only risen to 3.5% despite a year-to-year CPI at 7.5%.² There is also no glut of housing or capital spending weighing down economic growth. In our opinion, the seeds of recession have not appeared.

What we do have is a surfeit of liquidity no longer needed to foster economic expansion, and large Federal deficits that risk tax hikes that transfer private wealth to an already bloated government. Rising interest rates are the result. But absent runaway inflation, real rates are likely to remain subdued.

Market timing easily plays on our emotions in a way that overrides even the most well thought out plans. But if you stay calm, you’ll find that the likelihood of a positive return grows higher the longer you stay invested. Having a long-term plan, one that can work through market volatility, is one of the best ways to pursue your long-term goals and bolster your financial situation for years to come. While staying invested is the preferred overall strategy, careful asset class and security selection is required.

1. The S&P 500 is designed to be a leading indicator of U.S. equities and is commonly used as a proxy for the U.S. stock market.
2. Source: U.S. Bureau of Labor Statistics (https://www.bls.gov/). Federal Reserve Bank of New York Survey of Consumer Expectations (https://www.newyorkfed.org/microeconomics/sce#/inflexp-3).

Disclosure: BFSG does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to BFSG’s website or blog or incorporated herein and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy (including those undertaken or recommended by Company), will be profitable or equal any historical performance level(s). Please see important disclosure information here.