AFMC - Recession Storm Fears Reign Supreme As Stocks Gain Steam

Summary

• A big contributing factor to the surge in inflation was the spike in consumer spending.
• Healthy GDP growth, generationally low unemployment, and relatively stable earnings all point to a stable economy.
• While the future always remains unclear, nobody knows for certain whether a recession will occur this year or if the 2022 bear market will endure into 2023.

Commentators continue to shout the doom-and-gloom forecasts of a hard landing recession, but after an economic hurricane in 2022, there are some signs the financial clouds have begun to lift this year. The stock market has reflected this positive fundamental shift during January, as the S&P 500 catapulted +6.2%, NASDAQ +10.8%, and the Dow Jones Industrial Average +2.8%.

Last year, a major influencing cause of the -19% downdraft in the stock market (S&P 500) was due to the highest inflation readings experienced in four decades, compounded by a Federal Reserve hell-bent on slamming on the interest rate brakes. A big contributing factor to the surge in inflation was the spike in consumer spending fueled by trillions in government stimulus, coupled with widespread shortages in goods triggered by supply chain disruptions.

Fortunately, the headwinds of inflation now appear to be abating. Recently released inflation figures showed core inflation dropping from a peak of 9.1% last year to 3.5% in the fourth quarter ( see chart below ). Although the Fed will likely raise its interest rate target by 0.25% up to 4.75% this week, the downward reversal in inflation has raised the probabilities of the Federal Reserve "pausing" or "pivoting" on the direction of previous rate hikes. The odds of a halt or cut in rates will likely only increase if the descending trajectory of inflation persists and other upcoming economic data weaken further.

No Signs of Recession…Yet. Investors Waiting for Another Flood

While the calls for a hard economic landing remain, healthy GDP growth ( +2.9% in Q4 ), generationally low unemployment (3.5%), and relatively stable earnings (see chart below) all point to a stable economy with the ability to navigate a soft landing. China's new reopening of the economy and Europe's seeming ability of dodging a recession provide additional evidence for a soft landing scenario.

Although the bursting of the 2000 Tech Bubble had an outsized impact on the technology sector, the effect on the overall economy was more muted, as you can observe from the shallow decline in earnings. As the earnings show, during the Financial Crisis (2008) and COVID (2020), the crash in earnings was much more severe. Thus far in 2023, there has been no earnings plummet or sign of recession, and if financial conditions continue to soften, there is no reason we couldn't undergo a more vanilla, garden-variety recession like we did in 1990 and 2000.

Stairs & Elevators

While the future always remains unclear, nobody knows for certain whether a recession will occur this year or if the 2022 bear market will endure into 2023. However, as you can notice below, history over the last 70 years shows the duration of bull markets (average of about 6 years) are much longer than bear markets (approximately 1 year). I like to compare bull markets to walking upstairs in a tall building, and bear markets to going down an elevator. The main difference is that the stock market elevator generally never goes to the bottom floor and the stairs keep growing to record heights over the long run. Since World War II, Americans have experienced 13 economic recessions (see also Recession or Mental Depression? ). Not only are investors batting 1,000% in successfully surviving these recessions, but they have also thrived. From 1956 until the present, the S&P 500 has vaulted approximately 80-fold.

Presently, economic skies might not all be clear, blue, and sunny, but the fact that inflation is dropping, our economy is still growing, labor markets remain healthy, China has reopened for business, and Europe hasn't cratered all leave room for optimism. It may not be time to bust out the sunscreen quite yet, but the dark economic clouds of 2022 appear to be lifting slowly.

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (Feb. 1, 2023).

Disclosure: Sidoxia Capital Management ((SCM)) and some of its clients hold positions in certain exchange-traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax, or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

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