Justin’s Market Musings | Recession-Talk | August 02, 2023

We hope everyone is having a great Summer! It’s hard to believe the kids are back in school, and we are hitting the last full month of Summer 2023. I think for most of us, it has been nice having our investment statements look better than they have in a while. While we will always be happy for green numbers, remember we have some of the historically weakest months of the year coming up in August and September. Expect some weakness, at least in the short term.

Now to the topic at hand: RECESSION!!! As early as July of last year, we started addressing the non-stop talk about the looming “recession” that everyone seemed to be calling for. Our opinion was that we were NOT in a recession, and one wasn’t imminent, but we did feel that one was “likely in the next 12-24 months.” Well, we are 1 year removed from that blog post (read it here: https://lineawealth.com/the-r-word-july-27-2022/). And, while many former “bears” are now becoming “bulls” and those experts who claimed a recession was nigh are starting to change their minds, we still think there is a decent chance that we will see a recession in the next 12 months.

Why? Simply put, rate-hiking cycles from the Federal Reserve almost always end in recession. So, it would stand to reason that the MOST AGGRESSIVE rate hiking cycle in decades (perhaps ever) would lead to a recession. After last week’s hike, we are now at the highest rates we’ve seen in 22 years! So far in 2023, we’ve already had a mini-banking crisis, with several large regional banks failing back in the Spring. Most suggested that was due to the massive rate hikes by the Fed. Well, perhaps, but the Fed raised rates again twice since then and are suggesting they may not be finished! We have also witnessed one of the largest declines in the “Money Supply” (as measured by M2) in history over the last 15 months. Of course, this was preceded by one of the largest increases in Money Supply ever, thanks to the Covid era fiscal policy. Here is a reasonable explanation of this monetary phenomenon: https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-money-supply-falls-at-unprecedented-rate-possibly-cooling-inflation-75941751.

To suggest that there maybe some consequences that aren’t fully known yet would be an understatement. The last few years have really been unprecedented, both in terms of fiscal/monetary policy support (Fed cutting rates and Congress passing stimulus packages) and fiscal policy tightening (Fed raising rates and selling bonds to reduce their balance sheet). To think that the outcome can be easily predicted is naive. We won’t fully understand the ramifications for years, I suspect. We are still in a challenging period.

Fortunately, the decline in Money Supply and the aggressive rate hikes have helped cool inflation, which is a great thing! It had to be done. We assumed that would work and the market would respond positively in the first half of the year. But the sheer magnitude of the rate increases from the Fed, coupled with a cooling job market and a consumer that may be getting exhausted from several years of recovering from Covid lockdowns, ultimately should take a bite out of economic growth. We need to all remember that Monetary Policy changes (rate hikes/decreases) take time to work their way into the economy. We typically assume a 6-12 month “lag” before the effects are felt. This means that hikes from 6-9 months ago haven’t truly been realized in the economy. Also, historically, recessions don’t start DURING the rate hike cycle but after it is over, or even once the Fed starts reducing rates again. That’s our concern. We feel there is a bit too much exuberance and talk of a “soft landing” from the same people who told us a recession was imminent 18 months ago. Frankly, we think they were likely correct, just way too early to call for it.

So, what does this mean for asset markets (stocks/bonds)? Hard to say, but we’d be cautious here in the short run. Also, unfortunately, for yet another year, bond investors are really struggling to find returns. The good news is that with rates at multi-decade highs, conservative investors can find some attractive alternatives in CDs and Money Markets (we think this is temporary, though). And, IF and WHEN the Fed has to start cutting rates again (or even when it becomes obvious they will have to), Bonds should be primed for several years of above-average returns. Of course, this is after the worst year in bond market history (2022). Yes, a recession would damage the stock market, but we think balanced, well-diversified portfolios will hold up just fine. Our suggestion is to stay with your Asset Allocation, even if it feels like you are missing out on the party. Eventually, the party will be over, and those who partied too much may have a pretty bad hangover!

Stay patient. Enjoy the last weeks of Summer. I, for one am about ready to welcome Fall to the Calendar….

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. Economic forecasts set forth may not develop as predicted. Tracking # 463877