Given continued inflation and loose monetary policy, is a recession on the horizon?
Doubtful because the economic environment is doing better than many acknowledge right now. Currently, 91% of S&P 500 companies have reported Q1 2022 earnings. 77% of the S&P 500 companies have reported a positive EPS surprise, and 74% of S&P 500 companies have reported a positive revenue surprise. S&P 500 earnings rose 9.1% y/y in Q1, driven by a 13.4% rise in revenues. The earnings data helps prove to us the current 2022 stock market drop is a correction, mainly led by pessimism, and corporate earnings have plenty of room to continue exceeding expectations and for equities to rebound nicely before year-end.
Didn’t we have the most substantial fall in US productivity in 75 years?
Not exactly. Almost no one mentioned that the -7.5% annualized decline is a calculation factor. The US Bureau of Labor Statistics defines “productivity” as output per hour of labor, so if you take a close look, the denominator, workers’ hours, rose at a 5.5% annualized rate in Q1 2022, suggesting growth created more work and jobs, not less. It might also calm your nerves to know it’s not uncommon to have negative readings of productivity data (28% of the time during the last ten years).
If we have one more quarter of negative GDP results, won’t we be in a recession?
Remember, Q1 GDP data still needs to be revised a couple of times before final numbers are released, leaving plenty of room for economic upside surprises. Additionally, review the article we posted last month on the breakdown of the GDP figures to learn about many of the overlooked positives.
Would an FOMC policy blunder while trying to tackle inflation be detrimental?
Possibly, although monetary policy isn’t currently tight, and thankfully the growth in the M2 measure of the money supply has recently slowed. To quote Milton Friedman, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” But remember, our current inflation is due to supply constraints (not a quantity or velocity of money issue) due to Covid lockdowns. During the lockdowns with people stuck at home, demand moved faster than supply, and supply struggled to catch up with factories closed globally.
The supply issue will eventually balance itself out and could even be helped along faster, given that consumer demand is shifting back to services. It is too early to say inflation has peaked, but we will likely see decelerating inflation growth by year-end, with some pockets staying elevated a little longer due to the war in Ukraine. This deceleration can help lower long-term interest rates and give the Fed some breathing room to decrease the chance of a policy mistake.
What about the US record trade deficit?
Just because “deficit” infers something scary does not mean trade data is meaningful to markets or the economy. Trade deficits show that a country has a more robust demand for goods and services than its total export of goods and services. Moreover, imports reflect consumer demand (personal consumption). With trade data at new record highs, this is a positive given it’s the most significant driver of growth in the US and globally developed economies.
Could a rise in long-term interest rates and a stock market drop tip the economy into recession?
If this is possible, you need to ask yourself, “has it happened consistently in the past and globally?” The answer: No. Drops in financial markets and higher interest rates do not foretell recessions.
Unfortunately, none of the above topics stop the strong sentiment freakout in markets, which appears overdone and out of line with fundamentals and market-based long-term inflation expectations. So keep in mind that today’s higher prices for goods and services stem from supply shortages, not monetary excess, and therefore the Fed can’t do much about it with monetary tightening.
Thankfully, businesses are replenishing inventories as fast as possible, but inventories are still low relative to demand and sales. The low inventory levels let us know there is plenty of room for businesses to keep restocking shelves and showrooms in the months ahead to keep GDP moving forward.
Additionally, demand for workers remains robust, debt service costs are low for both consumers and US companies (40-year lows), we have low unemployment—heading lower, and severe bear markets tend to see both valuations deterioration and earnings deterioration. So far, we are only witnessing a P/E correction without an earnings deterioration—i.e., stock market correction.
None of the positives we outlined today predicts when the current correction tide will turn. Although, it nicely tees up Warren Buffet’s sage advice: “attempt to be fearful when others are greedy and to be greedy only when others are fearful.” So, get greedy because fear is in the street, and the markets will return ready to climb the wall of worry.