Defining a Recession

You could argue that the markets long ago “priced in” a recession. But back at the start of 2022, though, unemployment was near a record low, as it still is now. So, the self-proclaimed “official” recession callers at the National Bureau of Economic Research (“NBER”) haven’t said that U.S. economic activity is contracting just yet.

The label colors sentiment in the investing and business environment. Practically, it means credit conditions will be tight. Looking back at history, it becomes clear that the U.S. stock market “never bottoms before recessions. It bottoms during or after recessions.”

This chart of the S&P 500 Index since 1980, with gray areas indicating official recessions.

We’re not even in an official recession yet. Most are predicting it won’t start until later this year. That means the stock market bottom is still in front of us.

And those gray-shaded areas aren’t made “official” until well after a recession has begun or ended. According to the NBER’s Business Cycle Dating Committee’s explanation of how it picks out “peaks” and “troughs” in the economy.

The committee’s approach to determining the dates of turning points is retrospective. In making its peak and trough announcements, it waits until sufficient data are available to avoid the need for major revisions to the business cycle chronology. In determining the date of a peak in activity, it waits until it is confident that a recession has occurred.

In other words, if you’re waiting for mainstream officials to tell you on television that a recession is here, by then it will be obvious enough to everyone. And if they only announce the recession once the downturn is ending, you’ll hear it exactly when the information will be least useful or most confusing for making forward-looking investment decisions.

Veteran investor Tony Dwyer, who has 30 years in the markets and is the chief market strategist for Canada-based Canaccord Genuity, recently shared two simple indicators to watch.

Admittedly, you might see Dwyer on CNBC occasionally, but not giving “hot takes.” And he also talks elsewhere, such as non-mainstream podcasts like The Compound and Friends, where we heard this discussion…

Dwyer noted that…

Stocks typically haven’t bottomed until 23.5 weeks after the start of a recession.
A recession won’t beginuntil yield curves turn positive and the Fed starts cutting rates, not just pausing them. (Right now, for instance, the 10-year/2-year spread is still at negative 0.48%.)
An “official” recession won’t be called until the unemployment rate rises over a sustained period. This isn’t happening yet… Unemployment in April actually dropped a little to 3.4%.

On the third point, Dwyer said you’ll know we’re in a soon-to-be-called recession when the unemployment rate averages 50 basis points, or 0.5 percentage points, higher than the low of the cycle for three straight months.

Using current numbers and timing, that would mean to watch for when unemployment hits 3.9% for three straight months, as the most recent unemployment data for April checked in at 3.4%. (This is called the Sahm Rule in finance circles. It’s named for Claudia Sahm, a former Fed economist and not coincidentally a member of the NBER.)

That’s the point where Dwyer expects the Fed will be inclined to start cutting rates, or “pivot.”

A Fed pivot might sound like good news after 10 rate hikes over the past 14 months. And, indeed, history has shown a short-term bounce for stocks immediately after a Fed pivot. But these turns in rate policy have traditionally not been a buy signal for longer durations. Instead, they’ve been a sign of more pain for stocks because it means a recession is coming or already happening.

Remember, as we’ve also said many times, every bear market since 1955 hasn’t ended until after the Fed has started to cut rates. This is a reason why. As Dwyer said…

The final leg lower is when you’re in that recession and you’re going to make “the” low.

We will keep close eyes on signs for this “final leg” developing, but it might take a while. It’s also worth noting the only time a Fed pivot was a buy signal was in 1995. In that case, the pivot came with no recession, a circumstance also worth considering.

How does the Fed react to a recession? It lowers interest rates..

US Economy

The CPI report was roughly in line with expectations. US inflation continues to run hot.

– Headline CPI:

Source: @boes_, @gutavsaraiva, @readep, @economics Read full article

The Fed is no longer contributing cash to the US Treasury.

The government’s interest expense keeps rising.

The April payrolls report topped expectations. Again.

Mall visits are now substantially below last year’s levels.
The wholesale inventory-to-sales ratio climbed further in March, …

… as sales unexpectedly tumbled.

The NFIB small business sentiment index hit a multi-year low last month.

Sales expectations weakened.

CapEx expectations are crashing, …

… signaling further deterioration in business investment.

Source: Oxford Economics

Here are the reasons banks have been tightening credit standards.

Source: Oxford Economics

Source: CNBC Read full article

Here is the sticky CPI (3-month changes).

Market Data

The S&P 500 is nearing resistance again.

The S&P 500 financials index has been testing support.

Hedge fund clients haven’t been this bearish on stocks in at least a decade.

The Nasdaq Composite breadth deteriorated further this year.

The market continues to expect substantial rate cuts starting in the second half of this year.

BofAs private clients continue to dump REITs.

Investors are particularly worried about office REITs.

The US still has too many banks.

States with the highest interest from home searchers:

Quote of the Week

“I’m very different from your parents because your parents don’t want you to fail and be uncomfortable. They do everything in their power to make sure you don’t feel the pain that they felt growing up. And it’s probably their biggest mistake because you are going to fail. I love you enough to allow you to fail.”

– Dawn Staley, A Coache’s Diary