Do You See "Roses" or Thorny Recessions?
Jake and Tim recap some highlights and key thoughts from this week’s Quarterly Event and our special guest presenter.
Five Things You Should Know
Insights for Investors
“We can complain because rose bushes have thorns or rejoice because thorns have roses.” ― Alphonse Karr
Intro – Pessimists Abound
Look at any sentiment indicator and you’ll see historic levels of pessimism, though a simple glance at the news or coffee shop conversation would perhaps be just as effective at understanding the collective mindset of investors these days. In short, most people are focused on the thorns and looking past any roses that exist.
Is it justified? In part sure, there are a lot of troubling things in today’s world.
However, one should/could also ask themselves questions such as:
If one is honest, after reflecting on the above, they will likely conclude that while things may be frustrating and even frightening, their alternative courses of action are fraught with at least as much potential peril and potential losses over time.
Furthermore, there are several “roses” that could begin to bloom at any moment.
recession vs. RECESSION
As we tried to emphasize in the last few week’s commentaries, recessions do not come in just one form, let alone usually one that looks like a 2008 style recession. You wouldn’t know this from how people use the term these days to scare others, but the truth is some recessions are merely technical while others are tyrannical.
If one looks at the critical labor market if a recession does lie in our near future, it looks far more like the former than the latter – an outlook JPMorgan’s recent report noted as well.
JPMorgan summarized it this way, “The June jobs report painted a picture of consistency and strength in the labor market. The U.S. economy added 372K new jobs, remaining in line with the 383K average monthly gain over the past 3 months. Job growth was widespread, boosted by education and health services (+96K), professional and business services (+74K) and leisure and hospitality (+67K.). We also saw employment in manufacturing (+29K) return to its pre-pandemic levels. The unemployment rate extended its streak of 3.6% for the fourth consecutive month as the number of unemployed Americans stayed nearly unchanged at 5.9M. The labor force participation rate also remained quite steady at 62.2% vs. 62.3% in May. Wage growth continues to cool modestly with average hourly earnings rising by 0.3% after a 0.4% climb last month.
At a time when recession speak dominates investment conversations, the consistent strength in the U.S. labor market should be viewed as a bright spot. It is an important tailwind for the U.S. economy against the risks of hotter for longer inflation and falling consumer sentiment. It is also worth noting that since employment is a lagging indicator, the June jobs report does not eliminate the risk of a recession starting soon. However, with such robust labor demand, it does suggest that the next economic downturn could be a relatively mild one for American workers.”
This week’s latest employment data with continuing jobless claims falling 41,000 to 1.331 million lends further support to healthy job growth undergirding the economy at this time.
Despite some of the headline click-bait spins on JPMorgan CEO Jamie Dimon’s thoughts this week, he would seem to agree that fears for a “tyrannical” recession are largely unfounded despite the issues facing the economy. This is primarily due to his view that, “the consumer right now is in great shape. So even if we go into a recession, they’re entering that recession with less leverage and in far better shape than they did in ’08 and ’09.”
Similarly, Morgan Stanley CEO James Gorman stated that while issues exist, they are not “2008 complicated.”
Does this mean “the bottom is in”? Of course not, but there is good historical reason to believe we could be close as pointed out by Goldman Sachs this week discussing their research into typical market drawdowns during most recessions.
They noted, “Aggressive Fed policy action has driven the majority of US equity market contraction to date. While calling the market bottom remains challenging, history suggests that monetary policy-induced recessions have seen peak-to-trough S&P 500 drawdowns of -22%, on median. Though no two tightening cycles are the same, we believe today's starting point of macro strength may moderate further equity downside as rates begin to stabilize.”
Data and History Lend Further Weight to a Constructive Outlook
Former fund manager Scott Grannis highlighted another likely cause for the market’s recent stabilization stating, “The market is now beginning to look across the valley of still-high inflation this year to the other side when inflation news will start improving. Markets are good at reading the inflation tea leaves; if only politicians were so smart.”
He went on to add to his argument noting, “Thanks to the introduction of TIPS (Treasury Inflation-Protected Securities) in 1997, we have a direct reading of the bond market's inflation expectations for coming years. It's called the Breakeven Inflation rate, or the rate which will make you indifferent to holding nominal T-bonds or TIPS (and calculated simply by subtracting real rates from nominal rates). The bond market now expects the CPI to average 2.5% a year over the next 5 years, and that's down sharply from an all-time high of 3.6% registered in mid-June. Wow.
Consistent with the improvement in the outlook for inflation contained in these charts, the bond market has adjusted downwards, by a whopping 100 bps, its expectation of the Fed's target rate at the end of 2023 (was 4%, now 3%).
All good news, of course, especially since it means the risk of recession (typically brought on by a punishingly tight Fed) is likely lower than the broader market thinks. And it's a clear message to the Fed that they needn't (and definitely shouldn't) panic and raise rates too much or too fast.”
Where is this hope of a moderating inflation coming from after a 9%+ CPI report?
Of late, from all over. The cost to move freight that was $20,000 a container a few months ago is now $7,000 as the supply chains clears, rents actually declined in June as did used car prices, and of course most critically, the price of oil has now returned to pre-Ukrainian war levels (see chart below).
So, while inflation is still running hot in terms of the most recent data (e.g., this week’s Producer Price Index coming in up 11.3% versus one year ago and Consumer Price Index up 9.1%), those numbers reflect energy increases of 10%, and that catalyst will likely abate in future readings given the recent drop in oil prices.
Another explanation as to why markets initially sold off on the inflation report only to subsequently stabilize and rally were summarized wonderfully by Tom Essaye who explained, “Taken in the context that the S&P 500 is already down about 20% YTD, the market essentially viewed the hot CPI report just reinforcing what it already knew: 1) Inflation hasn’t peaked yet but there are signs it’ll peak soon, 2) The Fed won’t hike any more than currently expected (it may hike faster, but the end result should be the same) and 3) That the slowing economy will stay the Fed’s hand on rate hikes later in 2022 or early 2023, and in a year or so we’ll be talking about rate cuts.”
Another important reason was highlighted by Scott Grannis who pointed out the meaningful slowdown in M2 monetary supply (cash and cash equivalents in the system) which, after spiking due to the various COVID measures implemented by governments since 2020, has not grown for five months and counting. He concludes that consequently CPI will likely fall soon and, “that the Fed won't need to tighten dramatically or strangle the economy, as it has in the past” rather, “the economy is likely going to survive this bout of inflation without serious consequences. It will be painful for many, to be sure, but the economy needn't collapse.”
Just When It Seems Winter will Never End…
When things are really good or really bad it’s hard to believe they will ever change. And yet, history (and life experience) should remind us that while those feelings may be strong, the probability that they are true is not.
So here we sit after one of the worst quarters for the S&P 500 on record, and many understandably expect more of the same, but similar market drawdowns suggest the market will once again surprise many investors.
Take a look at the chart below showing market returns after similarly bearish quarters.
A related point from Bespoke shows that, “Following prior 20%+ two-quarter drops, the S&P has averaged a gain of 8.51% in the next quarter, a gain of 21.47% over the next half-year, and a gain of 31.36% over the next year. Looking specifically at next-year performance, the S&P has been up 7 of 7 times in the year following 20%+ two-quarter drops. The strongest next-year gain was the 46.57% rally following Q1 2009. The weakest next-year move was the 22.16% gain following Q3 2002.”
It has certainly been a painful start to the year, and while the “thorns” in the economy’s side hurt, they are not fatal, and the truth is that just like a rose bush, thorns of some form always exist. However, so do the “roses” and resilience of markets.
The choice of what you decide to see is yours.
And of course, any time you are struggling to see past those thorns please give us a call. We are always happy to talk with you.
Have a wonderful weekend,
Tim and the team at TEN Capital
Data, Just the Data
Data points this week included: