ILCB - Are Recession Worries Overshadowing Market Opportunities?

2023-04-07 01:56:00 ET

Summary

• Why markets are still ahead despite numerous headwinds.
• Is the robust U.S. jobs market finally turning a corner?
• The potential for a goldilocks scenario for markets and what it may look like.

Recent data suggests the U.S. jobs market may be softening, which could have big implications for the Fed, inflation and the economy. But Peter Hodson, Head of Research at 5i Research, says some investors may be focusing too much on slowdowns and not enough on corporate balance sheets.

Transcript

Greg Bonnell: Despite fears about inflation, rates, the health of global banks, the S&P 500 is still in positive territory for the year. But as we begin to see some signs of weakness in the US labor market, are some investors a little too focused on the end of rate hikes potentially and not enough on the risks of a recession?

Joining us now to discuss, Peter Hodson, Founder and Head of Research at 5i Research. Peter, great to have you back on the show.

Peter Hodson: Thank you.

Greg Bonnell: So let's talk about it. We've got a whole mix of things here, no shortage of things to worry about. And I find it interesting that as we waited for the labor market to cool, we finally get the signs in the market, it's trying to read all this, isn't it? What does it actually mean?

Peter Hodson: Yeah, it's one of those scenarios where good news is bad news and then bad news is good news. And so the market's been very worried about the labor market and labor pressure. And so to see some of the labor strength come off will be a positive sign. And of course, if companies don't hire people, then their profit margins can actually improve, assuming their revenues are not falling apart as well.

So it's a little bit of good, little bit of bad. You've got a situation where investors are concerned about this looming recession, yet we're not there yet. And yet, the market's sort of valuing it as if we were already in a recession. So if you compare it to '08, we were losing 400,000 jobs a month, and we're still creating jobs in the US.

So we're not quite in crisis mode, but investors are preparing for a crisis. That's what it seems like to us, anyway.

Greg Bonnell: Now as this all unfolds, obviously this is what the Fed has been watching in terms of trying to control inflation, and our central bank, the Bank of Canada. And they warned us all along, there'd be some pain in the economy, mostly pain in the labor market if we're going to tame those price pressures. The soft landing, the hard landing, where does this take us?

Peter Hodson: I think we'll probably do soft. Really, the corporate balance sheets-- and we won't talk about some of the problems in the US in specific regions and sectors-- but on average, corporate balance sheets are in really, really good shape compared to past cycles. Profit margins are good. You've got automation. Robotics is really helping productivity. And you've got a situation where the labor market, even though it's slightly weaker this month versus last month, there's still a job out there if you want a job.

And so as long as asset prices sort of stay there and there's not collapse in housing, or there's a collapse in this, that, and the other, I think we're going to be OK. And I think the market is sort of worried a little bit too much about a hard landing.

And honestly, most recessions last less than a year and they're priced in ahead of time in the stock market. So you're really looking at maybe a six-month window, if you want to exit and then come back in. And that might work once or twice, but--

Greg Bonnell: Yeah, timing the market gets awful hard.

Peter Hodson: Exactly. It's not going to work consistently. So if you've got a dividend stock that keeps paying you money, you've got a company that's still making money, you don't really have to worry that much about what's happening. This is just a regular economic cycle. Things are strong. They hike rates, slow things down, and carry on.

Greg Bonnell: Let's talk a little bit about the labor market. Because while it has been resilient through all this, you do get then a lot of headlines, and I'm thinking about the tech community in the States, like big numbers, 7,000 9,000, 10,000 jobs being trimmed at these behemoth tech companies. How do we put that in context with the overall labor market?

Peter Hodson: Well, first off, you have to wonder what these people were doing, if you can fire 10,000 people at one day. But a lot of it's coming from COVID. So COVID in the tech world, the demand surged and people were just scrambling to try and fill demand as everything changed in the pandemic. And they went on a massive hiring spree on anticipation of that trend continuing.

And then when things kind of got back to normal a little bit, that's like, hey, we don't need another 5,000 engineers to build this new app. And so there's a lot of that going on. And this is really interesting, because whenever a tech company announces a layoff, their stock usually goes up. Because again, it's all about profit margins. And if you can save 10,000 people making very high salaries, these engineers, your margins are going to improve dramatically.

So that is good for the headlines. It's good for psychology. But let's be fair. Most of these people that get laid off from a tech company, they're going to find another job pretty soon, pretty fast. There's still a shortage of talent out there.

Greg Bonnell: Now we mentioned off the top that despite all the things we have to worry about that the S&P 500 is still in positive territory for the year. But if you look at it year to date, it's been a pretty choppy ride. Should we expect that kind of volatility going forward, till we sort of settle out all of our fears and try to find a path forward?

Peter Hodson: I think, so if you look at the VIX volatility index, it's back below 20. And it was spiking above 30 not that long ago. So I think people are-- it's more of a calmer year. And so people have accepted the fact that rates have risen. They've accepted the fact that inflation is higher than what everybody wants it to be. But now they're used to that.

And so I think the next part of the market will be what happens next. Do we enter a recession? Is it deep? Is it shallow? Do we get another problem? Do we get an oil shock, like we had just the other day? And so it's a situation where I think the inflation, interest rate scenario, that's going to be old news. It's going to be priced in, and the market will look at the next crisis.

Greg Bonnell: For a while, for a long while, it felt like what the Fed was telling us about the path of rates and what the bond market was actually pricing in were pretty widely apart, widely divergent. I felt like, was there a brief week maybe at the beginning of the year where they came back together before they diverged again?

Peter Hodson: They agreed for about 10 days. And now the bond market is pricing in lower rates by the end of this year. And I think that would be a little too aggressive in terms of easing yet. I mean, the Fed's going to make sure that inflation's under control and the job market's under control before they do any sort of easing.

But I think we're on a path to seeing peak rates. We might get one or two more hikes, and then we might flatline for a period of time. And again, that's all about-- it's about uncertainty in the market. If the investor thinks that we're out of the rate hike cycle, then you can plan for that. You can do some modeling. The analysts can sort of predict cash flows. And it just becomes a little bit more of a normal market, where last year it was just a one inflation number and it really didn't matter if your company was good or bad or if you made money or didn't [make] money. It was all about those one numbers.

And so now we're getting back to fundamentals. So it's much easier, as an analyst, to look at a company these days, because you're not going to get blindsided by something.

Greg Bonnell: Yeah. We got another earnings season right around the corner, but we had one behind us. And I think heading into these earnings season, given the heightened volatility and the concerns we have, we say, oh, this is going to be the one where they come out with the tough medicine, they tell us. Did we actually see that from corporate America?

Peter Hodson: We didn't. We were really expecting kind of a kitchen sink outlook, basically. Companies, everybody looking at the stock was aware of what's happening in the economy. And it was such an easy quarter for them to say, you know what, we're going to be conservative, it's going to be a tough year, it's going to be a tough quarter. We're going to take this writedown. We're going to fire these people. And that didn't happen nearly to the extent that we thought.

So there's two things that could happen from that. Either the corporations have no idea what's going on in their business, or things are better than what they thought. And I think it's the latter. You're seeing inventory get drawn down, especially in the tech world, some of the tech semiconductor inventory is going down, and profit margins are holding up.

And so we've seen quite a few companies guide up. And so if you're guiding up when everyone's worried about a recession, that's a pretty positive statement of confidence from that particular company. So that's what we're looking for right now.

Greg Bonnell: What will you be looking at for the next earnings season? Any sign that perhaps they were a little too optimistic in the previous one?

Peter Hodson: Yeah, absolutely. I mean, you have to sort of guide and then beat. I mean, you have to sort make sure you can meet those expectations. But I think one thing to watch out for is going to be actually interest costs. I mean, there's a lot of companies that have a lot of debt, and some have hedged it and some have not. And so I think you're going to see a big divergence in companies that have managed the interest rate cycle well and those that were caught offside and suddenly are getting absolutely squeezed because their interest costs have doubled in the past year.

So that's OK if your regular business is growing and you can sort of offset it with growth. But if you're not growing, then that's going to be a problem.

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