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The economic data reports over the past month have consistently painted the picture of a more resilient economy than most analysts had expected. In typical fashion, many in the financial media have latched onto this, and begun collectively calling for a “soft landing.” The definition of this term is a rate hiking cycle that does not lead to a recession. We are in the camp of those who believe we are not likely to escape unscathed by this rate hiking cycle.
First, historically, the Federal Reserve has achieved exactly one soft landing since 1960 (63 years). There have been 9 recessions in the same period, most of which occurred as a result of, or in correlation with, a rate hiking cycle. This represents a historical probability of ~11%. The odds clearly are against this outcome. Further, the one time the soft landing was achieved was in the 1994‐1995 recession. That was a period where technology was expanding exponentially with the rapid growth of the internet, which changed all businesses and increased communication and productivity dramatically. There is an argument that Artificial Intelligence may have similar impacts, but the jury is still out on that, and productivity has been declining for most of the past few years. Finally, it is worth repeating an old maxim of investing “the most dangerous phrase in English is ‘It’s different this time.’”
All of this begs the question of how important the outcome of whether we have a recession or not is. Unemployment is at 3.57%, a very low level by historical standards. To put this in perspective, economists traditionally view 5% unemployment as representing “full employment,” or the long‐term sustainable labor market in a developed economy. Said another way, the economy is still running very hot and could likely correct to more normal sustainable levels without a great deal of pain. In fact, this is one of the stated side effects of the hiking cycle that the Fed has explicitly mentioned in their statements, which indicate that slightly higher unemployment is desirable in their view. In any event, any recession on the horizon is expected merely to return the labor market to a more sustainable condition, while bringing inflation under control.
In terms of markets, the S&P 500 is trading up nearly 20% year to date, and has been in a bullish pattern since May. This is despite news that has been “bad” at times, and the hallmark of a healthy market is that it ignores bad news and rises on good news. We are trading near levels not seen since March of 2022 when the recent bear market was in its early innings. Earnings season has delivered surprisingly strong results so far, with most of the S&P done reporting. Notably, only Materials and Utilities have surprised to the downside in Sales on aggregate, while all sectors have delivered strong upside surprises in Earnings. This implies that firms have adjusted to what we see as a persistent, higher inflation environment than we have been accustomed to. In terms of rates, income investors are getting 4.5% to 5% in yields for high grade corporate bonds.
In short, we have a favorable outlook for markets regardless of the hiking cycle and whether that leads to recession. If you have questions about markets, the economy, or your investment plan, please let us know, we are here to talk.
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