Wealth Management

Posted by Jeffrey J. Roach, PhD, Chief Economist

Wednesday, August 10, 2022

Headline CPI eased in July to 8.5% year-over-year from 9.1% in June. Still above the Federal Reserve’s (Fed) long-run target rate, the annual rate of inflation seems to be cooling. As shown in the LPL Chart of the Day, inflation is easing as durable goods prices continue their descent from recent highs. For example, prices for appliances have declined for three out of the last four months and used vehicle prices declined four out of the last six months. “The July inflation report should change market expectations about future Fed activity,” explained Jeffrey Roach, Chief Economist for LPL Financial. “As inflation eases, the Fed can now tighten monetary policy at a slower pace.” The Fed still has a lot of work to do, but pricing pressures seem to be easing.

View enlarged chart.

The latest inflation report is welcomed news and could add support for the Fed to raise rates at a slower pace in September. However, the headline measure of inflation may be too good to be true because of the nagging price increases to rental costs.

Watch Out for Rent

Recent pricing trends for rent of primary residence is alarming. Since November 2020, monthly changes in rental costs have accelerated. Last July, rental costs rose 0.2% month-over-month and then inched up to 0.7% month-over-month in July 2022. The booming housing market explains most of the rise in rental costs. During the recent period of unusually low mortgage rates, housing demand skyrocketed and home price appreciation reached new levels. High housing costs pushed many homes out of reach for would-be millennial buyers and for first-time buyers with no pre-existing home equity. High demand for homes and low supply created insurmountable hurdles and pushed many to be renters instead of home buyers.

Fed Could Hike 50

As inflation rates slow, the Fed could revert to a 50 basis point (or 0.5%) increase at the next meeting of the Federal Open Market Committee (FOMC) in September. Inflation is the primary concern for policy makers. Although the employment situation is the other mandate for the central bank, inflation is currently the greater risk. The labor market is a key variable for investors as they anticipate future moves by the Fed. A slowing job market is a risk, especially since firms are announcing more layoffs. For more on the labor market and its relationship with Fed policy, be sure to watch our latest Econ Market Minute, where Chief Economist Jeffrey Roach gives more economic insights.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks 

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.

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The Case For Recession Weakens

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Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist

August 8, 2022

The most watched, and arguably the most exciting, soccer league in the world kicked off this weekend across the pond: the English Premier League (EPL). It’s set to be an enthralling season for the many EPL fans around the world as some of the world’s biggest soccer (or football as it’s called over there) teams battle it out for supremacy, in what is also the most lucrative soccer league in the world for its constituent teams.

As of the latest United Kingdom (U.K.) government estimates, the premier league is estimated to contribute over $10 billion per year to the UK economy. Much of the financial success of the league has come from selling the television broadcast rights both domestically but also increasingly outside of the U.K. (including the $2.7 billion that NBC just paid for rights to broadcast in the US for the next 6 years, extending its current deal that has been in place since 2013, out to 2028). Worldwide an estimated 3.2 billion viewers watched at least one EPL match during the 2019-20 season, in almost a billion separate households. Perhaps it’s the accessibility of the games being broadcast in the English language but the EPL has left its rivals, Germany, France, Spain and Italy, who often get the better on the field, in its dust off it. The EPL brings in over $3.5 billion in TV money per season; almost double the Spanish “La Liga” league and more than the Italian, German and French leagues combined.

“U.S audiences watching premier league soccer have increased massively as TV coverage has increased and we anticipate this ramping up even more as we build up to the U.S hosting the FIFA world cup in 2026,” said LPL Financial Portfolio Strategist George Smith “Of course, we’d never suggest investing based on this, but the superstitious amongst you would not be surprised to hear that a team wearing red winning the premier league has historically been a poor sign for stocks”

Just for fun we took a look at which EPL teams the stock market, as measured by the S&P 500, seemed to cheer. Going back to the start of the premier league era in the 1992-93 season (prior to this it was known as the English Football League Division 1) seven different teams have won the league. The stock market looks like it likes one hit wonders as it has never been down in the calendar year in which a team won the EPL for the first time. The average best return, +34%, has occurred when Blackburn Rovers won, for the only time in 1995, but unfortunately for those of us hoping for such an omen for 2023 Blackburn was relegated out of the EPL in 2012 and has been struggling in the lower divisions ever since. Manchester City won the season that just ended in May 2022 but finishing this year with a 15% calendar year return may be a stretch after the historically bad first half we saw. It will also not surprise Arsenal fans that their team is bad luck and that their team winning coincides with a measly 4% average return and sub-par batting average.

View enlarged chart.

We know that some traders are very superstitious about the color red so we also decided to look at the predominant color of each team’s home uniform (or kit as they would say in England). So far no team has ever won the league that doesn’t have either a blue or red home uniform and it turns out that a red team winning does correlate to more red in the markets, with a lower average return, worse batting average and much worse drawdowns when they do occur:

View enlarged chart.

Lastly, we wanted to look at the nationality of the winning team’s head coach (or manager as its known out there). Amazingly, no team coached by an Englishman has ever won the premier league but seven other nationalities have. Spanish, German and Italian winning coaches posted well above average returns and the stock market has never been down in any of the four years that an Italian prevailed!

View enlarged chart.

If you haven’t yet chosen a premier league team to support and want some good luck for the stock market as well our calculations point to a team that doesn’t wear red, would be a first time winner and has an Italian manager: Tottenham Hotspur. Tottenham is the only member of the so-called “big 6” premier league teams, who dominate the league financially, that has never won the EPL. Leeds United, who wear white and are coached by the American Jesse Marsch, could be a fun, but very unlikely to succeed, selection.

LPL Research would like to reiterate that in no way shape or form do we recommend investing based on this data, but here’s to a great premier league season for all you soccer fans out there!

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

• Not Insured by FDIC/NCUA or Any Other Government Agency
• Not Bank/Credit Union Guaranteed
• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by Jeffrey J. Roach, PhD, Chief Economist

Friday, August 5, 2022

The economy added 528,000 payroll jobs in July after a solid gain in June and May. The strong gains in the job market last month should further cement the claim that the U.S. is currently not in recession. As shown in the LPL Chart of the Day, both the three- and six-month moving averages rose in July since the last two months were revised higher. Job gains were broad-based and especially prominent in sectors such as education, health care, and government. Firms ramped up production and increased manufacturing payrolls by roughly 30,000 in July. New jobs in manufacturing are likely due to improved supply chains and this sector should continue to add jobs as remaining supply bottlenecks improve. Total employment has returned to pre-pandemic levels in February 2020 but not back to pre-pandemic trends. The participation rate dipped slightly to 62.1% as the labor force shrunk in July by 63,000 and the unemployment rate fell to 3.5%, a decline of 0.1% percentage point.

View enlarged chart.

Given the stability in the job market, especially considering rising borrowing costs and higher inflation, we do not expect the National Bureau of Economic Research (NBER) to call a recession at this point. The labor market is strong enough to offset the weaknesses in other parts of the economy such as real estate.

Growing Frustration
The decline in unemployment and the participation rate will frustrate central bankers since a tighter labor market adds inflation risk to the economy. So far, earnings have not kept up with inflation. Average hourly earnings rose 0.5% in July after rising 0.4% the previous month. As of July, average hourly earnings were 5.2% higher than a year ago.

Markets are having trouble digesting the implications of the strong labor market in July. The big headline gain in jobs was a surprise and could convince people like San Francisco Fed President Mary Daly that the economy needs another 75 basis point hike at the Fed’s next meeting. All eyes are now on inflation.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks 

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.

Posted by Jeffrey Buchbinder, CFA, Equity Strategist

Thursday, August 4, 2022

Prospects for a burst of growth in China once the reopening occurs has been a tempting investment thesis for emerging markets (EM) as much of the rest of the world has already reopened. But as we wait for that event, it’s clear we may be waiting a while longer. Meanwhile, House Speaker Nancy Pelosi’s trip to Taiwan and ongoing war in Ukraine have made it more uncomfortable to advise investors to hold anything more than a small emerging market (EM) equities allocation in portfolios. Remember, China composes roughly one-third of the MSCI EM Index. Add Taiwan and the total is near half.

“We’re all for international diversification over a long-term strategic time frame,” according to LPL Financial Chief Equity Strategist Jeffrey Buchbinder. “But it’s really tough to advocate for that right now tactically as the economic and geopolitical environment worsens outside the U.S. The strong dollar doesn’t help.”

As shown in the LPL Chart of the Day below, the days of booming economic growth for emerging market economies have long passed. Historically, faster growth in EM countries has generally been accompanied by relatively good EM stock performance compared to developed markets (DM). COVID has been an unwelcomed equalizer, leading to very similar economic growth this year in all of these markets. Meanwhile, China’s economic transformation to more of a services economy and away from low-value manufacturing and massive infrastructure spending has also shrunk this gap.

Though an EM economic growth premium will likely return in 2023 with EM likely to outgrow DM by a fairly decent margin, the geopolitical risk that comes with EM investing suggests caution is prudent.

View enlarged chart.

The earnings outlook in EM isn’t particularly enticing for investors either. As shown in the next two charts, estimates for EM have been revised sharply lower since Russia invaded Ukraine. That leaves EM earnings growth lagging the U.S. and likely developed international as well over the next 18 months. The more than 10 percentage point haircut is not just Russian earnings coming out of the index (though that’s part of it). Also consider EM’s track record of meeting earnings estimates over the last decade has been spotty.

View enlarged chart.

View enlarged chart.

Lastly, technical analysis also tells us that the outlook for EM may be weakening. Not only is the index setting lower lows and lower highs, as shown in the top panel of the chart below, but relative strength of the MSCI EM Index compared with the S&P 500, shown in the bottom panel, is also in a downtrend that is at risk of breaking below prior lows.

View enlarged chart.

So what is there to like about EM? Besides a possible but long-awaited reopening in China, valuations are the big positive here. EM is trading at a 37% discount to the S&P 500 Index on forward price-to-earnings ratio (P/E) basis (using the consensus earnings per share estimate for the next 12 months). The 15-year average discount is just 23%. Valuation is not enough to recommend an investment in our view but it sure helps in this case.

View enlarged chart.

In summary, the lack of a big economic growth advantage, earnings weakness, and deteriorating technical analysis signals suggest being on the cautious side of neutral despite attractive valuations and an eventual reopening in China. Add to that heightened U.S.-China tensions and war in Ukraine and the risk-reward in EM is not as attractive to us as it was earlier this year. For those who wish to allocate to EM equities, we would encourage using active management to help navigate geopolitical and governance risks.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks 

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.

Second quarter earnings season is rolling and, after a bit of a slow start, the numbers have been pretty much as we anticipated.

Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Wednesday, August 3, 2022

LPL Financial held its FOCUS conference at the Colorado convention center in Denver, CO from July 24-27 for over 4 thousand financial advisors. Today we bring you the second part of the most frequently asked questions that LPL Research received at the conference. “FOCUS is such a great event because it allows LPL Research to connect with so many advisors and understand their most pressing questions about the state of the markets,” said LPL Financial Asset Allocation Strategist Barry Gilbert. Following on from yesterday’s blog where we looked at the FOCUS 2022 questions relating to the economy below we share some of the most frequently asked questions we received on the stock and bond markets:

• What would it take for the S&P 500 to break down below the 2022 lows?

The bottoming of stock markets is a process so while we have a positive view on equities a retest of the June S&P 500 low would not surprise us. Around the June S&P 500 lows we did not see the levels of market capitulation or fear to believe that all potential sellers have been flushed out, so it’s entirely possible for there to be another wave of selling after this bounce. We did however see more of the market signals that typically occur around, or after, market lows. We discussed this in more detail in our recent “Was That The Bear Market Low Part 2” blog. On a more fundamental level a lot of uncertainly remains in the markets and while none of these are our base case risks remain. The primary risk is the Federal Reserve (Fed) overtightening, whether due to a policy mistake or an appropriate response to inflation not cooling as expected and more importantly inflation expectations becoming untethered. Overtightening could push the economy into recession with significant job losses and damage to companies’ earnings. Military conflict spilling into Europe outside of Ukraine or a Chinese aggression towards Taiwan are also non-zero risks that would provide negative shocks to global financial markets. Although, as shown in the below chart, when we look back at historic events the S&P500 has recovered relatively quickly (average 42 days) from the mild drawdowns that have accompanies past geopolitical shocks (average -4.7%).

View enlarged chart.

• Does LPL Research believe the rebound in growth stocks will continue?

The rebound in growth stocks, from somewhat oversold conditions, has been strong over recent trading sessions but we believe a slight tilt toward the value style is still prudent for now. Renewed confidence in economic and earnings growth and stable interest rates would set the stage for the growth rebound to continue, as these conditions would allow growth stocks superior earnings power to shine. At the present time however there is a lot of uncertainty and we believe growth stocks are still relatively expensive and could still be susceptible to valuations compression if inflation continues to put upward pressure on interest rates.

• Which stock sectors does LPL research currently favor?

LPL Research recommends a modest tilt toward defensive sectors and away from cyclicals as the second half begins with uncertainty still elevated. Our favored defensive sectors include healthcare and real estate, while the near-term outlook for the energy sector remains positive on both a fundamental and technical basis. The aforementioned conditions for a style shift toward growth (falling inflation, stabilizing economic growth and interest rates) may also drive a turnaround in some sectors with technology, the most important, so that is one to watch for the second half of the year.

• What is LPL Research’s view on bonds? Is the worst over?

Despite the historically poor start to the year, the value proposition for bonds has actually improved year-to-date, although the 10-year Treasury yield is now well of its 2022 highs. Even after the recent pullback the yield on most fixed income asset classes is still close to the highest levels we’ve seen in a decade and since starting yield levels are the best predictor of future returns this could still be an attractive opportunity for income-oriented investors. And while we certainly can’t guarantee that interest rates won’t return to 2022 highs, even at current yields, the risk/ reward for owning fixed income has improved dramatically, in our opinion.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

• Not Insured by FDIC/NCUA or Any Other Government Agency
• Not Bank/Credit Union Guaranteed
• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by George Smith, CFA, CAIA, CIPM, Portfolio Strategist

Tuesday, August 2, 2022

LPL Financial held its FOCUS conference at the Colorado convention center in Denver, CO from July 24-27. LPL Research was proud to be part of this annual event that allows thousands of LPL’s financial advisors to experience industry-driven sessions elevated by the extensive knowledge and experience of LPL executives, industry leaders, and dynamic guest speakers. “LPL Research had the pleasure of speaking directly with many advisors during the FOCUS conference,” said LPL Financial Portfolio Strategist George Smith “recession risks are clearly front of mind as we answered many questions on this, among other interesting topics”. We wanted to share some of the most frequently asked questions about the state of the economy and the answers we gave during those conversations:

• What is the “correct” definition of a recession? Are we in, or going into, a recession?

The National Bureau of Economic Research (NBER) looks for economic declines that are significant, broad-based, and persistent. Or, to use the terminology of the NBER business cycle dating committee, the three criteria are “depth, diffusion, and duration.” We are probably currently not in a recession. At least not yet. Consumer spending was too strong in Q2 to satisfy the requirements of a significant, broad-based, and persistent contraction. Recession risks however are rising, with recent increases in unemployment claims as an ominous sign. For more details, please see our recent “Are We In A Recession Yet?” blog.

• How long is the average recession? How long is the average expansion after a recession?

Since World War II (WWII) the average recession has lasted 10 months, although 2020 was the shortest on record at just 2 months, and is followed by an average expansion of 64 months. We are currently 27 months into the expansion that started in May 2020. If the economy does fall into a recession within the next 7 months this expansion will be the 3rd shortest since WWII (with only the early ‘80s and late ‘50s expansions shorter).

Indexes cannot be invested into directly. performance referenced is historical and is no guarantee of future results.

View enlarged chart.

• How does the stock market react to recessions?

Somewhat surprisingly, stocks have actually gained ground in half of the recessions since WWII. The S&P 500 gained 1.3% on average when looking at the 12 previous recessions, with a very impressive median advance of 5.4% (the average is skewed lower due to the large drawdown in 2008). The last 3 recessions, however, have all led to stocks declining.

Indexes cannot be invested into directly. performance referenced is historical and is no guarantee of future results.

View enlarged chart.

• When do stock markets bottom during recessionary periods?

Stocks tend to lead the economy with all but one recession since WWII seeing stock markets bottom before the recession officially ends (remember NBER calls the end of a recession with about a year delay). This was even true during the COVID-19 related recession that only lasted 2 months. The only exception was in 2002 when the market bottomed 11 months after recession ended.

View enlarged chart.

• What would it take for the Federal Reserve (Fed) to be more aggressive / less aggressive?

We continue to think the Fed will likely increase rates this year up to approximately 3.5% as long as inflation pressures persist and the labor markets hold steady. The Fed’s next monetary meeting is not until September by which time the Fed will have two more months of inflation and jobs data to mull over. At that point, if inflation is stubbornly high, with some sectors yet to decelerate, and a still strong jobs market, then the Fed would likely continue to aggressively tighten financial conditions. If inflation does cool, even marginally, and businesses are significantly increasing layoffs to cut costs in response to a weakening economy then this could lead to a much less aggressive Fed. In that case, the Fed could begin cutting rates again as early as 2023. We still expect a 50 basis point hike in September but that will be very dependent on the economic data we get over the next two months. For more details, please see our recent “Fed Meeting Recap” blog.

In tomorrow’s blog we will take a look at the most frequently asked questions that we answered at FOCUS 2022 in relation to equity and fixed income markets.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

All index and market data from FactSet and MarketWatch.

This Research material was prepared by LPL Financial, LLC.

Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).

Insurance products are offered through LPL or its licensed affiliates.  To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

• Not Insured by FDIC/NCUA or Any Other Government Agency
• Not Bank/Credit Union Guaranteed
• Not Bank/Credit Union Deposits or Obligations
• May Lose Value

Posted by Jeffrey J. Roach, PhD, Chief Economist

Friday, July 29, 2022

What Does A Recession Look Like?

What necessary ingredients do we need to bake up a recession? The National Bureau of Economic Research (NBER) looks for economic declines that are significant, broad-based, and persistent. Or, to use the terminology of the NBER business cycle dating committee, the three criteria are “depth, diffusion, and duration.”

Because the committee looks at a broad swath of the economy, the important metrics cover the labor market, consumer income and spending, and industrial production. A recession is when these broad-based parts of the economy experience a significant and persistent downturn.

Are We in One or Not?

We are currently not in recession. At least not yet. Consumer spending was too strong in Q2 to satisfy the requirements of a significant, broad-based, and persistent contraction. “Although we are probably not in a recession, risks are rising. One ominous sign is rising unemployment claims,” warned Jeffrey Roach, Chief Economist at LPL Financial.

As shown in the LPL Chart of the day, Q2 GDP fell an annualized -0.9%, quarter-over-quarter. However, consumer spending on services grew in Q2, contributing to headline economic activity for the 8^th consecutive quarter. Inventory rebuilding is one of the most volatile activities in the economy and is sometimes a wildcard in forecasting. Although the U.S. has now experienced two consecutive quarters of negative growth, investors should remember that recessions do not always correlate with headline GDP data. For example, in 2001, the U.S. had a recession yet growth was 2.5% in the second quarter.

View enlarged chart.

Higher interest rates are weighing heavily on business investment. Declines in general business capital spending reveals a budding weakness in the corporate sector of the economy and could be an ominous sign. Another disconcerting sign in the economy is the weekly claims for unemployment insurance benefits. Initial unemployment claims are trending upward, a more ominous sign than the negative Q2 GDP report. After yesterday’s update, the 4-week moving average of initial claims is up to 249,000. The low point was 171,000 in April. Rising claims indicate a weakening labor market.

What Can the Federal Reserve Do?

Committee members are increasingly concerned about weakness in consumer spending and manufacturing. In recent months, the one bright spot was the labor market as job gains were solid. However, as businesses increase layoffs to cut costs, the job market will likely cool in the latter half of this year, complicating things for central bankers.

As long as inflation pressures remain, the Fed will feel compelled to continue tightening financial conditions. Therefore, The FOMC could raise the target rate another 1% by the end of the year but that is predicated on a solid job market, which is not a guarantee as businesses have recently increased layoff announcements.

The best scenario investors can hope for is like the mid 1990s. The economy escaped recession as the Fed pivoted from increasing rates to cutting rates when labor markets weakened.

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks 

References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.