Market Update September 2022 – Another Shot at a Soft Landing???
What makes a market? For starters, it requires participants with differing opinions. No shortage of that today! The lead subject for debate may very well be concerns of a “recession”, although its definition has morphed into different versions. For most investors, the technical definition of recession is not as important as what the term implies, mainly a slowing economy and rising risk of decline within the capital markets. Today, the term “recession” may get the attention, but the real point of investors’ focus is on the details regarding Federal Reserve (Fed) policy, interest rates and corporate earnings.
It’s well publicized that the Fed’s primary goal during this time is to tame heightened inflation, primarily by raising the Federal Funds Target Rate. This tool, in turn, ripples through the US financial system resulting in higher rates broadly throughout capital markets. But what this means for the broader economy going forward is debatable in the midst of current concerns. For example, strategists from three well respected firms see the future differently in the excerpts below.
- We maintain that inflation will resolve on its own as distortions fade, and likely drive a Fed pivot, while a stronger H2 (second half of 2022) recovery in China should provide support for the global cycle. This, in combination with still very low investor positioning, creates a positive environment for cyclical assets. JP Morgan View (8/24/22)
- Morgan Stanley strategist Michael J. Wilson cut his expectations for earnings-per-share growth for the year, saying that a slowing economy is now likely to be a bigger concern for stocks, rather than scorching inflation and a hawkish Federal Reserve. In 2023, he expects earnings to fall 3% even in the absence of a recession… Bloomberg (9/6/22)
- Since the FOMC started hiking the funds rate early this year, we have argued that the US economy can achieve a soft landing, even though the path is narrow. It requires sustained below-trend output growth, a rebalancing of the labor market via sharply lower job openings coupled with a moderate rise in unemployment, and a large decline in inflation. While much can still go wrong and our probability that a (mild) recession will start in the next year remains about one in three we see some encouraging signs that the economy is moving toward all three of these goals. Jan Hatzius – Goldman Sachs Global Views (9/5/22)
While it remains to be seen if we will enter into an official recession, as determined by the National Bureau of Economic Research (NBER), the consensus agrees that 2022’s current conditions are the result of prior actions necessary to combat global economic stress stemming from 2020’s COVID-induced shutdowns. It’s been well documented that the abrupt economic shock uniquely influenced the nature of the recovery, resulting in genuine concerns that demand has outpaced supply conditions, a recipe for heightened inflation.
Which brings us back to an important question central to the COVID era recovery: Can/will inflationary pressures naturally improve systematically? Could this improvement take place with a lesser degree of Fed intervention than is currently being discussed,e.g., lesser rate hikes than those discussed today? These are tough questions to answer definitively, but even marginal improvement considered as “better than expectations” could soften the process of normalizing economic conditions.
And to this point, the chart below is an example of economic datapoints that might be currently pointing us towards a more orderly reset and supporting a path of a lesser degree of intervention than currently discussed. The Federal Reserve Bank of New York’s Global Supply Chain Pressure Index integrates transportation cost and manufacturing indicators to gauge global supply chain indicators. If a disruption/lack of supply (red arrows) has indeed been a primary cause of heightened inflation, it stands to reason that data improvement causing the Index to recede off recent highs (green arrows) would be a positive development in the fight to tame inflation.
The three opinions expressed above capture well the current climate of investors – much debate and little consensus. And the differing opinions in the marketplace (not to mention the slow cadence of new economic data paired with the choppy seasonality in the in early fall) suggests that the market picture may be muddled for a time. No one single factor will prove to be the definitive answer for what’s next for the economy and markets. But the trend in this chart provides a hopeful picture that current disruptions may be abating.
Chief Investment Officer
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