The U.S. economy could be heading for a recession in the next year, according to growing warnings from banks and economists, as a sudden bout of pessimism hammered financial markets this week. Of note was comments from Fed Chair Jay Powell earlier this week, that suggested that the Fed’s sole aim was to curb inflation at all costs which included cooling the economy to achieve its goals. The Fed, which had stuck to its easy money policy along with the Congress to pump billions into the economy last year, for the first time, appears to be taking the other side and cutting its ties to the stock market and the economy.
The effects of higher interest rates are already showing in results from Walmart, Target, Macys, Lowes and other retailers who are seeing the shift in spending from merchandise to services. One of the first signs of recession are declining profit margins of US companies and as companies battle higher wages, tight labor market and high inflation while demand drops, profit margins get squeezed. And the cycle continues as companies begin layoffs, cut costs and protect their profit margins, unemployment starts to increase as the economy slows down and we eventually end up in a recession.
Future Wealth’s View
We, at Future Wealth LLC, would argue that we may be close to hitting bottom in the equity markets in terms of valuation if only the Fed would continue to be the backstop. Most corrections and bear markets begin to turn when every single sector has seen precipitous drops from previous levels. Barring the Energy sector that has been artificially inflated due the Ukraine war, every other sector – Housing, Consumer Staples, Materials, Consumer Discretionary, Retail, Industrials, Tech, Semiconductors and Financials have dropped into correction territory this year. The S&P 500 and most of the other sectors are now back to historical P/E valuations.
Barring the Fed’s reluctance to support the equity markets, we believe that we could be witnessing a market rally shortly. But as Nobel Laureate Paul Krugman, himself an economist, wrote in a beautiful article titled “Why most predictions by economists are wrong”, we would confess our prediction is based on a limited amount of data and certain assumptions that suggest a recovery in the stock market.
If that were to happen, investors holding on to their positions in growth stocks and meme stocks will be disappointed as we believe the recovery in equity markets will be in a fundamentally different environment of high interest rate and slower growth in the economy. The radical shift in the investment landscape from the past 10 years means investment portfolios will need radical changes as well.