The economic outlook may not be as bad as the market fears. Here’s where investors should be looking
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The stock market is plummeting, inflation is rising and consumers worry more about the future. All of this is not good news, however it is time to put the brakes on fears that all is going wrong. The fear of recession is on the rise especially after one quarter of the U.S.’s negative GDP growth in Q1. This was 1.4% less than the 0.4% that it had in Q1. Only one more will be enough to bring the economy under the thumb definition of a depression. However, the labor market continues to thrive. Companies are filling on average more than half a million open positions a month in 2022, wages are rising — albeit not as fast as the cost of living — and companies are still making money at a healthy clip, registering a 9.1% profit gain in the first quarter, according to FactSet estimates. Markets are still plagued by the inflation problem. Once that slows, the good news is it can increase consumer and investor confidence. Unfortunately, it could be a long time before that happens. It may even take years. There are many factors which influence the rapid price increase. You have the effects of huge fiscal and monetary stimulus and supply chain backlogs due to the pandemic. There is also the risk from the conflict in Ukraine. You have to ask yourself if the United States is at risk of experiencing a recession on the economic front. Jim Paulsen (chief investment strategist, The Leuthold Group), stated that the answer to his question is “no”. “All those fears apart are just one fear. All of these fears are tied to inflation. That is the key. It is still a subject of heated debate whether 8.3% inflation and accompanying Federal Reserve rate increases to reduce it are enough to bring down the economy is the question. Wall Street economists tend to raise their expectation for recession. Goldman Sachs expects only a one-in-3 chance of it, and Deutsche Bank foresees sharp declines in growth late in 2023. According to the New York Fed, a reliable gauge that measures 10-year Treasury yields against 3-month Treasury yields indicates that there is a 3.7% probability of recession at the end of April. Evercore ISI Chairman Ed Hyman said that inflation may have peaked recently. David Tepper of Appaloosa Management, an eminent hedge fund manager, told CNBC recently that he’s selling off his Nasdaq short position because the constituents who are most at risk from higher interest rates. The persistence of inflation, though, is scaring investors enough to send the tech-focused Nasdaq well into a bear market and the S & P 500 and Dow Jones Industrial Average not far behind. It’s all about the technicals. We need to see a bottom. Paulsen explained that while we should see capitulation there are still technicals that continue to break. Paulsen believes that the fundamental picture is better than what the technicals show, due to the strength and stability of both the corporate and household balance sheets. Along with Marko Kolanovic, a JPMorgan strategist, he also believes that inflation peaked in March. The household debt increased steadily last year. This culminated in an 8% rise in the fourth quarter, bringing the total to $16 trillion. According to Federal Reserve data, the share of disposable income is only 9.4%. This is half a point lower than before the pandemic. The ratio of corporate debt to GDP is also lower than before Covid. Paulsen advised investors to focus on long-term strength, and then invest accordingly. He points to frontier markets, emerging markets excluding China and the all-country index excluding the U.S. MSCI as places that could outperform the S & P 500. You can play frontier markets through the iShares MSCI Frontier or Select EM ETF. Columbia EM Core ex China ETF is one way to play China. It is difficult to find safety while still outperforming in the current market environment. Scott Knapp is chief market strategist for CUNA Mutual Group. He aims to thread the needle by betting on a brighter future and addressing the reality of the moment. Knapp’s initial “hard-landing” scenario requires the Fed to increase its inflation rate aggressively in order to keep it below 2%. The Fed does this by reducing growth and inflicting more market pain. He allows for the possibility that inflation may react faster to interest rate increases and need less Fed tightening. “The shift in [inflation]Expectations cause a rally that will likely occur before the market is even aware of it. He said that a rally such as this will not be revered like most rallies.” It’s unlikely that people will believe this until they see it in the rearview mirror. Knapp suggests a portfolio where investors are willing to take on longer duration risks, which is counterintuitive in an inflation scenario. Investors should also ensure a stable commodity allocation, but they shouldn’t be overweight. He said that investors should think more like options traders than they do rely on unreliable forecasts. We need to assess the probability and make investments across the range, but also have hedges for left-tail events. Options traders don’t rely on the ability to forecast the future. ‘…With boxing gloves, those whose job it is to see the future will be able to see a dark picture. It is trying not to curb inflation but also try to stop growth. History shows that this can be a hard, but not impossible task. The consumer isn’t sure it’s possible. Friday’s University of Michigan confidence survey was widely watched. Long-lasting goods buying conditions reached their lowest level since 1978, which marks a 10 year low. The Fed is comfortable with the levels of inflation expectations, which are at 5.4% for next year and 3% for five- to ten years. Joseph Brusuelas (U.S. chief economist, RSM) said that they are trying to thread the needle using a pair boxing gloves. We’re currently in an extremely difficult position here. If they can engineer a slowdown of 1%, it would be a disaster. [GDP growth]They’re going cause growth recessions while declaring victory. This is a very difficult situation. Reverberations can be felt across many sectors of the economy. Cass Freight Index April revealed a 0.6% decline in April volumes following an increase in volume of 0.5% March. And the report’s accompanying narrative wasn’t very encouraging. According to the report, “Freight volumes have dropped with a thud after nearly two years of increasing freight volumes.” As substitution from goods back into services increases and inflation slows overall spending (especially via increased fuel prices and higher interest rates), the prospect of freight depression is very likely. Brusuelas estimates that the likelihood of recession within the next 12 month is about 33%. He also includes the wildcards like the Ukraine or Covid lockdowns. Deutsche Bank, with its most negative forecast on Street, has praised Fed Chairman Jerome Powell (and his fellow central bankers) for the pursuit of an inflation-friendly path, in spite the risks. [Federal Open Market Committee]Knowing this from the pain of the 1970s and 1980s, our colleagues believe that the faster the problem with inflation is addressed the less expensive it will be and the sooner economy returns to more favorable growth paths,” the bank wrote in a note for customers. The Fed knows that the path ahead is not easy, however the Fed is determined to make it so.
Traders are seen working on the New York Stock Exchange’s floor in New York City (USA), May 13-2022.
Brendan Mcdermid | Reuters
Consumers are becoming more worried about the future as inflation rises and stock markets tumble. While none of these are good signs, it may be time to take a step back from worrying that all is lost.
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