Market Update with Aled Phillips

The last week has seen volatility in markets spike higher and stock markets fall. You will no doubt see a raft of headlines on the stock market action with the focus of the argument being on whether the US is going into a recession. Later on we will address some of the arguments being talked about the US recessionary fears, but first, let’s provide some context around the moves over the past few days.

Why?

In essence, this a combination of several factors coming together. 

During July, we have seen weaker inflation, and economic data increasing the expectations that the Federal Reserve (Fed) would start to cut interest rates. Last week the Fed held rates, disappointing investors with the expectations now focused on the first Fed rate cut being at their next meeting in September. Markets have also increased their outlook for cuts, with three cuts of 0.25% each expected this year (two had previously been priced in) with a total of 1.5% of easing by June 2025.

This disappointment with the Fed and weaker economic data has also coincided with the Q2 earning seasons where investors have been generally underwhelmed despite two thirds of the companies that have reported (around half of the S&P 500) beating analysts’ expectations. The concern is for growth stocks and their lofty valuation may not be sustainable going forward. This is natural after such a strong run, but if you look back at the last few quarterly earnings, this concern has also been in place. It would be more concerning if recession was looming, but we do not believe this is the case, a view shared by the investment managers that we invest with.

Are recession fears justified?

The amount of easing priced in since the Fed meeting last week seems unlikely to occur without a recession and the fact that the Fed is only a month away from easing at a time when the economy remains resilient 2.8% GDP growth for Q2, does not suggest a recession is just over the horizon.

So let’s examine some of the evidence of why that seems to be the case.

• “Burnt out Savings”:  You may often read that consumers have used their “excess savings” generated from Covid.  This is a technically flawed argument; consumers have not drawn down on their savings to support spending as if they had the personal savings rate would have turned negative - which has not occurred.  Indeed, the overall cumulative wealth in the US is at its highest level seen 2020.
• Household stress: This has been dramatically cut since 2008, with the household sector debt to disposable income ratio now at a 25 year low. Others have noted that the credit card delinquency rate has risen, and this is true, but credit card debt is only 6.3% of total consumer debt.  Whilst lending institutions appear to be in reasonable shape and are beginning to lend money again.  Expanding bank credit is not consistent with an economy that is close to dropping into recession.
• Labour market: Financial markets have been spooked by rising unemployment claims with last Friday softer than expected data propelling further negative sentiment. But context needs to be applied, monthly payroll growth of 114K would be considered “normal” prior to Covid. Job participation rate is still climbing and there is evidence that the this move in labour data is down to a rise in labour supply rather than a falloff in labour demand. The disappointing data on Friday was unwelcome but with an unemployment rate below 4.5%, this doesn’t scream a recession.
• When considering whether the US is likely to fall into a recession it is worth remembering that historically economic or financial crisis are a necessary condition. This is because these crisis’s stop economic activities, forcing businesses to liquidate assets and lay off workers, whilst consumers tend to save more and spend less as job losses surge. The good news is that there are currently no obvious signs of financial stress and that according to the Kansas Fed Financial Stress Index, financial stress has been easing since early this year.
• The recent sharp selloff is a warning shot that the Federal Reserve doesn’t have much time or space left to begin easing and there is little to no room for them to disappoint in September.

Looking forward

• The general consensus is that the Fed will cut rates in September. The last time the Fed cut rates in an expanding economy was in 1998 on fears of recession and falling inflation and this set up a sharp rally into the start of the millennium. We are closer to this scenario and the 1990s, where the internet bubble was supported by increased IT investment and gains in labour productivity, again, a similar picture to today with the AI boom and changes in labour working practices.
• We have been warned that as we head into the second half of the year volatility would increase and we continue to expect this to occur. It again follows a similar pattern to the 1990s where stock market corrections were steep and vicious followed by a rally that was equally as furious. 

In Summary

These market movements are completely normal in a market cycle, and after a long and sustained price movement upwards are somewhat expected. It is easy to get blind-sided by press articles, but these movements are irrelevant in a long-term investment plan, and we would already have factored these in and stress-tested your financial plans to account for this. As ever, this article is intended to give our view on current markets and is not a “call to action” or a prompt to change portfolios as the managers we use will already be adjusting portfolios if any when they see fit to do so.

Even if we are heading into recession in the US, then timing it is impossible and the best course of action as ever is to remain calm and stay invested, as this disciplined behaviour pays off significantly over time, as any short-term market movements are just that, and will reverse.