It happened, just not all at once. What follows are excerpts from an article from the Capital Group, the parent company of American Funds.
Different sectors of the economy have experienced downturns at different times. Thanks to this rare case of a “rolling” recession, the U.S. may not experience a traditional recession at all this year, even with the dual pressures of elevated inflation and high interest rates.
“I am increasingly seeing signs that we may not get a broad-based recession,” says Capital Group economist Jared Franz. “Instead, what we are getting are mini-recessions in various industries at various times without much synchronization.”
Different sectors have experienced downturns at different times
Residential housing, for instance, contracted sharply in 2022 after the U.S. Federal Reserve started aggressively raising interest rates. At one point in 2022, existing home sales tumbled nearly 40%.
“Now it looks like the housing market is starting to recover while other areas of the economy, such as commercial real estate, are beginning to spiral down,” Franz explains. “As more people work from home, the outlook for office real estate is particularly troublesome.”
Likewise, the semiconductor industry was plagued by broken supply chains and lower demand for computer chips in 2022. That sent semiconductor stocks plummeting. In 2023, the business has stabilized, demand has returned, and semiconductor stocks are driving a rally in the global equity markets.
If these contractions and recoveries continue, Franz explains, we could wind up in an environment where U.S. gross domestic product does not turn negative at any point in 2024, thus averting one of the most widely predicted recessions in history.
“I still think a short, mild downturn is possible,” Franz says. “But if consumer spending doesn’t crack, then this widely expected recession could be like the boogey man who frightened everyone but never showed up.”
Indeed, the federal government reported a strong economy throughout 2023. The surprisingly strong growth was driven by stable consumer spending and dramatically higher business investment, up 7.7% on an annual basis.
Consumer and business strength has also contributed to a red-hot labor market, with healthy job creation and an unemployment rate of 3.6%, near a 50-year low. “Recessions are nearly always associated with broad-based job losses,” Franz notes, “and we just aren’t seeing that right now.”
What about the inverted yield curve?
On the other side of the recession debate, many economists have argued that an inverted yield curve is the most reliable recession predictor that we have. Right now, the inverted yield curve — which happens when the yield on short-term bonds is higher than the yield on long-term bonds — appears to be screaming for a recession. And it has been for more than a year.
An inverted yield curve has preceded every U.S. recession over the past 50 years. The current yield environment is more inverted than it has been since the early 1980s. This powerful signal has convinced many economists and bond market investors that a recession is inevitable in the next year or two.
Could that view be wrong? Or at least a misreading of the bond market? Yes, says Pramod Atluri, principal investment officer of The Bond Fund of America.
High inflation, which we also haven’t seen since the 1980s, is the key determining factor today, Atluri believes. Fed officials have made it clear that fighting inflation is their priority, and they appear to be achieving their goal of bringing prices back down to earth. Inflation fell to 3% in August from 9.1% a year ago, a remarkable decline in just 18 months.
That means Fed officials may be able to cut interest rates in the months ahead, not because they expect a recession, but because they are close to achieving their stated goal of 2% inflation.
Is an inverted yield curve no longer a reliable predictor of recessions?
“An inverted yield curve means the market is predicting that the federal funds rate will be higher today and lower tomorrow. That’s it,” Atluri adds. “The yield curve is not predicting an impending recession. It is predicting that inflation will be lower in the future and, therefore, the Fed will be able to end its rate-hiking cycle.”
“As a corollary, if inflation gets back to 2%, then an inverted yield curve will once again be a good predictor of declining economic growth and rising recession risk,” Atluri concludes.
What are the investment implications of a soft landing?
“Earlier this year, I was very concerned about a recession,” says Chris Buchbinder, a portfolio manager with The Growth Fund of America, “But I have eased off that expectation and, in my view, I’d say the probability now is below 50%.”
That view has led Buchbinder to consider investing in companies that are traditionally impacted by recession worries but have proven to be resilient — particularly in the post-pandemic recovery period. Pent-up demand has benefited many companies in the travel and leisure industry, for instance, as well as aerospace and aviation.
Semiconductors, chemicals, and oil are also interesting, he says, given their recent difficulties and growing signs of a turnaround.
“This has been Godot’s recession; we’ve all been waiting for it,” Buchbinder says. “But because of that fear, many companies started pulling back in anticipation of a downturn. The Fed started raising rates. And now there are fewer imbalances in the economy. So there are fewer things that can go wrong from here.”
Bottom line is that the markets should do quite well this year, despite the downturn this week. In about two weeks earning reports start coming in for the fourth quarter and I suspect they will be positive enough to move the markets up. The markets turned the corner in October and I believe it is because the economy has a strong foundation and consumers continue to spend. It won’t be a straight line up this year, but all the fundamentals point to a very good year.
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