By Tim Courtney, Chief Investment Officer
In late 2020 and through 2021, economic growth accelerated to high levels, topping out in the 6% to 7% range.1 Spending rebounded strongly and markets achieved tremendous growth, with most broad equity, real estate, and commodity assets growing between 70% and 140% from their March 2020 lows to the end of 2021.2 Repeating those kinds of numbers in 2022 was not going to happen, and a slowdown in economic and market price growth was assured.
The GDP reading, after inflation, was negative for the first quarter and even with the number being surprisingly low, markets were positive the day of the report. 3 Consumer spending, business investment, and home building all grew, things you normally don’t see during a recession. But the “R” word is being used in news stories more and more, and here are three signals or risks that are increasing the odds of an upcoming recession.
- High inflation. Prices rose 8.5% in March,4 well above the levels the Fed economists thought possible back in early 2021. If this persists, consumers will begin cutting back on purchases. High inflation has pushed interest rates higher, making borrowing more difficult and in turn, causing real estate price increases to slow. Strong asset prices have kept households healthy the past few years since homes and portfolios have been rising in price, but the commodities and consumer goods inflation won’t help.
- Inverted yield curve. The bond market tries to predict what future growth will be like through interest rates. When the yield curve inverts, it’s a sign that future growth may slow or contract. The yields have been fluctuating between a normal and inverted curve for several weeks.5 The yield curve isn’t a perfect indicator but it is something we watch along with other data points.
- Geopolitical risks and the global supply chain. Many factors are affecting the global and U.S. economy, from the war in Ukraine to labor shortages and continuing pandemic-related issues, such as China locking down major cities and limiting industrial production. These problems have interconnected effects and will take time to sort out. In the meantime, they are increasing the chances of a recession.
There’s no such thing as a risk-free environment, and today’s environment arguably has more than its fair share of uncertainties. We will inevitably enter a recession at some point, but whether that occurs soon or many quarters from now is unclear.
Other market signals, such as prices for lower-quality bonds or the behavior of smaller, weaker companies compared to those of larger, stronger companies are not indicating a recession. Neither are earnings expectations, which so far, have risen in 2022. The market’s behavior still appears to be driven by a rise in interest rates from a near-zero level and it is becoming acclimated to the new environment.
We are beginning to see what we consider undervalued assets after several quarters of having most assets at the high-end of fair valuation. If you have any questions about these issues or your portfolio please contact your Exencial advisor.
- St. Louis Fed (FRED) — Gross Domestic Product
- Morningstar (12/31/21) — Morningstar Direct measuring S&P 500 Index, Russell style and size equity indexes,
MSCI international indexes, FTSE REIT indexes, Alerian MLP index, S&P commodity indexes
- CNBC (4/28/22) — U.S. GDP fell at a 1.4% pace to start the year as pandemic recovery takes a hit
- Forbes Advisor (4/12/22) — Why is inflation so high?
- CNBC (3/31/22) — 2-year Treasury yield tops 10-year rate, a ‘yield curve’ inversion that could signal a recession
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