Thoughts - Recession Fears Are Overblown
There's lot of talk about recession risks in the media. We think the recession fears are overblown and here's why.
I originally intended to write about Europe’s Doom Loop for this week’s Friday issue, discussing how the European Central Bank is paralyzed despite soaring inflation and a crashing Euro. However, I’ve been busier than usual and won’t be able to do the topic justice if I rushed the research and writing.
As such, for this issue, I’ll be brief and tackle a subject with a more limited scope. Recession fears. In particular, I wanted to expand on a point I made in this week’s Market Forecast issue about how we’re nowhere close to a broad-based recession, in the practical sense.
Let’s start.
A Possible Recession? What’s Important to Know
Recession, recession, recession… we’re constantly hearing this in the news and social media these days. The hardships of the recession that started from the 2008 Great Financial Crisis are still deeply ingrained in the American psyche. This is likely why any inkling of a possible recession sets the media abuzz with recession talk. The good news is, I don’t think we’re close to a recession.
Here’s why.
There are many different definitions for a recession. The one that matters, in my opinion, is where consumer spending drops. This triggers a vicious cycle in which company earnings fall and resources go idle, prompting companies to layoff people, which further reduces consumer spending.
American consumers are far from slowing their spending. Consumers went into 2022 with more than $2 trillion in excess savings, the job market is historically tight, wages are rising, this is the first post-pandemic summer, and the strong US dollar is dampening the cost of commodities.
Yes, inflation is eating into the consumer’s confidence and balance sheet, and rising interest rates are increasing capital costs for companies, but companies are absorbing the higher costs and enduring lower margins to meet strong demand from the Relentless American Consumer™.
The best signal for this is the June jobs report, which came in a lot hotter than expected. Consumers are spending more, despite soaring inflation, and companies are hiring to meet the strong demand, despite rising interest rates.
One might wonder whether the ongoing tech and real estate layoffs portend an impending recession.
Far from it.
Both sectors are highly interest rate sensitive and got way ahead of themselves in the last two years of ZIRP (Zero Interest Rate Policy). With the Fed making a sudden about-face with interest rate policy and rapidly raising rates in the last quarter, a contraction of over-hiring and over-investment is expected. The rest of the economy is significantly less interest rate sensitive. For example, consumers won’t hesitate to hold a wedding, go to Disney Land, or buy the new Macbook Air just because Jerome Powell decided to raise the Fed Funds Rate by 100 basis points in the latest FOMC meeting.
So the bottom line is that the biggest risk for a recession right now is waning consumer demand, but the American consumer is too strong for us to be close to that. Recessions in Europe and developing countries could push American companies over the edge and trigger layoffs but this is partially balanced out by falling commodity prices and a reopening China, which by the way, is actually loosening monetary policy just as the West rushes to tighten.
I’ll end with two notes.
First, one popular definition of a recession is two declining quarters of GDP, but GDP can decline without widespread layoffs. For example, GDP declined in Q1 2022 but that’s only because government spending fell. GDP might also decline in Q2 2022. If so, it will cause another bump in recession talk in the media but practically, we’re still far from the vicious cycle of less spending, layoffs, less spending, layoffs.
A second note is to caution readers that even if we don’t enter a recession in the practical sense, the stock market can still decline precipitously. This is because stock market valuations are a function of earnings and as input costs rise, earnings take a hit.
NASA released a slew of full-color ultra resolution images from the James Webb Space Telescope (JWST) on Monday. Here’s one showing the famous Carina Nebula. Probably my favorite of the bunch.
Did you know that the reason all the stars in the photo have 6 points of light coming out of them (diffraction spikes) is because the JWST has hexagonal mirrors?
It’s incredibly exciting to think about what other deep space photos and discoveries the JWST will produce. This simple diagram below really highlights the enormous space-peering capability that the JWST has relative to any other telescope humans have built.