S&P 500: Everything Leads To A Recession, But Not Anytime Soon

Seekingalpha2023-09-14

Recent developments in artificial intelligence have brought back euphoria in the financial markets, with the S&P 500 achieving a year-to-date performance of 17%.Key macroeconomic indicators suggest a ...

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Comments

MIe
2023-09-14
MIe
Deflation trend
Chris Tan
2023-09-14
Chris Tan
US is notorious on faking news. Even economic data cannot be trusted given the global slowdown 😁😁😁
aaffsmcjje
2023-09-14
aaffsmcjje
There will be one. Anytime can happen. Big dogs will decide when only

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even the Fed thought so. Indeed, with the failure of SVB earlier in the year - that sent us through a bad start, as of today all this negativity seems to be behind us. Recent developments regarding artificial intelligence have brought the euphoria back up in the financial markets, and the S&P 500 (SPY) has achieved a year-to-date performance of 17%.The labor market is resilient, the stock market is rising, a recession is no longer expected, and inflation is falling. In short, everything seems to be heading in the right direction and the future looks bright. But is this really the case?Granted that I do not possess a crystal ball, my thesis is that the market is discounting an overly optimistic scenario, which leads me to doubt the future performance of the S&P 500 (SP500). Key macroeconomic indicators are far from positive, but the market does not seem to care for the time being.First aspect: Refinancing riskWhen the Fed started raising interest rates in March 2022, we could not have predicted that we would reach the current level.Federal Reserve Bank of St. LouisAfter years of expansionary monetary policy, in only a year and a half the Fed Funds Rate reached the 2007 level and the cost of borrowing definitely shot up. This was one of the fastest restrictive monetary policy moves in history, and there was not enough time to realize the effects of such a large move. Back then, the market reacted negatively and lost more than 20%, but the bear market was short lived and today we are back in the bubble of euphoria.Inflation is coming down and it would seem that the impacts of monetary policy have not affected businesses and households too much, but this is a misperception, in my opinion. Monetary policy never has an immediate effect on the economy; rather, it often has a lag of several months if not years.To support this claim I show you a study published recently by the Federal Reserve Bank of Boston.Federal Reserve Bank of BostonThis graph shows how long the Fed Funds Rate increase takes before it's fully discounted in the corporate interest expense ratio. The moment when the effects are maximized is five quarters after the increase, or one year and three months later. Based on this study, the implications of this in the current macroeconomic environment are staggering.Federal Reserve Bank of St. LouisIn other words, the fully discounted hikes in the corporate interest expense ratio are only those until June 2022, or 150 bps out of the total 525 bps. Thus, the effects of monetary policy are still in their earliest stages and the most acute period is yet to come. But why does this lag exist?The first reason is that even if the cost of borrowing increases, firms do not always need to take on debt immediately. It may take months if not years before the debt matures and then needs to be refinanced. Before borrowing at high rates, companies could take advantage of their liquid reserves.The second reason is that we come from a decade of unprecedented expansionary monetary policy. Markets have been doped with liquidity, and before these resources are fully depleted, time is needed.A rate cut could facilitate the soft-landing scenario, but for now the chances of that happening anytime soon are very low. Inflation is still an issue and the market is discounting the pivot in May 2024. Keeping the Fed Funds Rate high until that point would maximize the effects of tightening monetary policy.Federal Reserve Bank of BostonTypically, the corporate interest expense ratio has almost always been higher than the Fed Funds Rate. Since rates will remain high for a long time, I expect the current divergence to represent only a temporary situation. In fact, the interest expense ratio already has seen a potential start of an upward trend beginning in mid-2023. By mid-2024, I would not be surprised if it surpasses the Fed Funds Rate.Having observed the effects of monetary policy on businesses, let us now see what's happening to households. They too are having quite a few problems.Federal Reserve Bank of St. LouisIt had not been since 2000 that a 30-year fixed-rate mortgage cost so much, or just over 7%. Only two years ago it was possible to get it for even less than 3%.This increase obviously discourages any investment in the housing market and makes it difficult for a family to buy a new home. The difference between a 30-year mortgage at 3% is abysmal compared to 7%. Assuming a mortgage worth $300k, in the former case the monthly payment is $1,264, in the latter it is $1,995. But the Fed Funds Rate increase does not only affect housing.www.forbes.comThe average credit card interest rate has skyrocketed, reporting figures near 30%. No such level has been reached since the Fed has been monitoring this data (1994). The all-time high was around 16% in the 2000s.www.forbes.comJust as with the mortgage, such an increase has a significant impact on household finances. There's much more interest to be paid, and this reduces disposable income and savings.Federal Reserve Bank of St. LouisThe constant monetary stimulus combined with lockdowns had made 2020 and 2021 ideal years for saving money. Indeed, this was the case as we can see from this chart. However, this period was very short lived and now it will be much more complex with such high interest rates.Federal Reserve Bank of St. LouisFinally, I would like to conclude this paragraph with this image. Delinquency rates on credit card loans remain low compared to the historical average and especially to 2008. This is certainly positive, but in recent months this figure has gotten much worse. Debtors are beginning to feel the burden of interest, and since the effects of monetary policy have yet to fully manifest themselves, I doubt there will be any improvement in the coming months. One thing is certain: If this ratio ever rises too much, the stock market cannot ignore it.Second aspect: Tightening does not please the marketsAs anticipated earlier, the stock market has been accustomed over the past decade to continuous quantitative easing that has resulted in one of the most bullish periods ever. However, sooner or later the consequences must be faced.Federal Reserve Bank of St. LouisBoth during the great financial crisis and during the pandemic, the injection of liquidity into the system was unprecedented in history, but today we are in a totally different context. Inflation is high, so it's necessary to keep the Fed Funds Rate high, and the liquidity injected in previous years will be gradually drained. This process is called quantitative tightening and is applied simply by not rolling over maturing assets within the Fed's balance sheet.Federal Reserve Bank of St. LouisOf course, not all the liquidity injected will be drained, only part of it. This process began in April 2022 and has drained $864 billion so far.By relating the M2 monetary aggregate and the S&P 500, their correlation is obvious. So, if the former is gradually falling, it's unlikely that the latter will not be affected.TradingViewTypically, the monetary aggregate M2 tends to rise over the long run, as does the S&P 500, but there are times in the short run when the correlation is more or less pronounced. In the case of the pandemic, the market began its ascent at the time when monetary stimulus increased M2. Today, however, the correlation is less pronounced. M2 is gradually falling but the S&P 500 is challenging all-time highs. In my view this divergence is not sustainable. Since I doubt that the Fed will increase M2 in the short to medium term, I expect S&P 500 to converge downward reestablishing the correlation.Finally, keeping with the tightening theme, commercial banks are adjusting their standards for commercial and industrial loans.Federal Reserve Bank of St. LouisHistorically, when banks tend to ask for more collateral before lending it's because the macroeconomic environment is fragile. Since 1998, when this figure exceeded 60% there has always been a recession. Today we're at 50.80% and the trend is upward. With interest rates set to be high for the next few months, I don't see how this dilemma can be solved.Third aspect: Correlation between unemployment rate and S&P 500One of the main factors underpinning bullish theses on the S&P 500 is based on the resilience of the labor market. The unemployment rate has remained at historic lows despite the sharp rise in the Fed Funds Rate, a signal that the economy has not experienced a major contraction.In this respect I agree, in fact all of this is a positive sign. However, as I have already said at length, I believe that the full effects of monetary policy have yet to manifest themselves. At that point, the unemployment rate could rise quickly.Game of TradesAs we can see from this picture, recessions always are accompanied by a rising unemployment rate, and the bottom always comes before the highest level is reached.We're currently at 3.80%, the highest level since February 2022. For August 2023, analysts expected a lower value of 30 bps. For now, employment remains the strength of the U.S. economy, but then again, that's always the case before a recession.If we wanted to reason about the right timing for investing, we should buy the S&P 500 when the unemployment rate is high not when it's at historic lows as it is now. In general, when employment is that high, it's much more likely to get worse than to get even better.Fourth aspect: LEI index and yield curveThe last two aspects I want to cover in this article are the study of the yield curve and the LEI index. Both are very accurate indicators when it comes to predicting a recession. Let's start with the former.Federal Reserve Bank of St. LouisSubtracting the 3-month Treasury yield from the 10-year Treasury we get the figure shown above. As we can see, since the 1980s, when the spread fell below 0%, a recession followed in the following months/years. When the yield curve is inverted, financial intermediaries are unable to operate in the usual market conditions, and this leads to an economic slowdown/recession. In fact, banks used to borrow money in the short term in order to employ it in the long term, but if short-term rates are higher than long term rates, the mechanism stalls. The inverted yield curve is synonymous with an economy in trouble, and we're in that phase today.Having said that, I would like to clarify one last point that is often misunderstood: Recession does not occur at the moment when the yield curve inverts, but at the moment when the spread becomes positive again. This is a crucial aspect that would explain why there has been no recession so far. For it to happen, it's necessary for the Fed to start cutting interest rates, but this is not expected before May 2024.The Conference BoardAs for the LEI index, the argument is similar: We're well below the signal that indicates the risk of a recession. In the past this indicator has also been 100% accurate (at least from 2000 onward).Economics is not as certain a science as mathematics, so we cannot be sure of predicting a recession through these two indicators. Anyway, assuming that there will be no recession means going against a statistic that has so far experienced the maximum accuracy.My point of view regarding the recessionKey macroeconomic indicators are signaling that we are at the dawn of a new recession, however, I do not think it is appropriate to create alarmism.First of all, recessions should not be seen as only a negative event but as an opportunity to buy great companies at a discount.St. Louis Fred & MorningstarThe S&P 500 has overcome all kinds of difficulties over the long term, including wars, world pandemics, and terrorist attacks. Most of the time this index performs positively, and it's inevitable that there also are downturns. Moreover, the average length of a recession is not even high, between 2 months and 18 months: Typically the market bottom comes even before the end. In short, the term recession should not be scary for those who keep their nerves in check and have a portfolio composed of solid companies with a competitive advantage. What we're experiencing today will have minimal impact for those who invest for the long term.Second, this recession is unlikely to occur anytime soon. There are mainly four reasons for this:The first is that based on the study of the yield curve, before the recession occurs it is required that the 10yrs-3month differential turns positive again. For this to happen, the Fed would have to cut rates and it's unlikely before May 2024. As long as the spread remains negative, the evidence leads us to assume that there will be no recession. We are currently well below the 0% threshold.The second is that the huge liquidity injection of the last decade is postponing the recession. There's still a lot of liquidity available and not all companies have already refinanced their debt at higher rates. It's a process that takes time as we saw earlier in the study published by the Federal Reserve Bank of Boston. We need at least another 5-6 months to maximize the effects of restrictive monetary policy.The third is that, relying on statistics one more time, the performance of the last 4 months of 2023 is likely to be positive.BMO capital Markets Investment Strategy Group, FactSetWhen the return of the S&P 500 between January and August exceeds 15%, typically the next four months show a positive performance. The only exceptions were in 1986 and 1987. However, in the case of 1987 we're talking about an atypical situation dictated by the famous Black Monday in which there was a collapse of more than 20% in a single trading day. The odds of that event were 1 in 1 trillion, which is why I consider it an outlier in this list. Based on this statistic, the return of the S&P 500 will be 87% positive between September and December 2023, probably around 4.30%. Of course, it could happen that we are in the 13% range, but I personally always prefer to stand in favor of the statistic.The fourth is that there's still too much hype in the financial markets, and we can see this in the price per share of companies like Nvidia (NVDA) and Tesla (TSLA). The artificial intelligence bubble triggered the recovery of the S&P 500 and I doubt it's about to burst in these months.For all these reasons I believe that at least in 2023 there will be no recession; a different matter for mid-2024. By that time I believe the Fed already has started cutting rates, the unemployment rate has risen, and the banks will be at the peak of stress. I hope that at least the inflation problem will be solved, otherwise the Fed Funds Rate reduction may be slower than expected.I would like to make it clear that this represents only my opinion and I could be wrong even though statistics seem to be on my side. I do not claim to predict with certainty the performance of the S&P 500 in the coming months, and frankly I do not feel the need to do so either. Doing market timing most of the time is a fallacious strategy at the end of the day given the unpredictability of the future. Sometimes it is better not to overcomplicate things and simplify them as much as possible.Recession or not, my strategy will continue to be the same: Buy solid companies when they are at a discount. I welcome the recession, so I will have more investment opportunities since they are scarce today. There's still too much hype about the stock market, and perhaps it's time to focus more on bonds. The latter may be the subject of a future article.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[{"id":219838002573440,"gmtCreate":1694701486987,"gmtModify":1694701491133,"author":{"id":"3577182936341023","authorId":"3577182936341023","name":"MIe","avatar":"https://static.laohu8.com/default-avatar.jpg","vip":1,"hat":"https://static.tigerbbs.com/f84d87792f02cf78e80ee34979fd31e5","crmLevel":5,"crmLevelSwitch":0},"htmlText":"Deflation trend&nbsp;","listText":"Deflation trend&nbsp;","text":"Deflation trend","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":0,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/219838002573440","repostId":2367754489,"repostType":4,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"},{"id":219816405438544,"gmtCreate":1694696210984,"gmtModify":1694696215306,"author":{"id":"4100325483048030","authorId":"4100325483048030","name":"Chris Tan","avatar":"https://community-static.tradeup.com/news/234d0c8219838a66f0165bcb29277534","vip":1,"crmLevel":2,"crmLevelSwitch":0},"htmlText":"US is notorious on faking news. Even economic data cannot be trusted given the global slowdown 😁😁😁","listText":"US is notorious on faking news. Even economic data cannot be trusted given the global slowdown 😁😁😁","text":"US is notorious on faking news. Even economic data cannot be trusted given the global slowdown 😁😁😁","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":1,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/219816405438544","repostId":2367754489,"repostType":4,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"},{"id":219806595514480,"gmtCreate":1694693816539,"gmtModify":1694693820946,"author":{"id":"3557887424829909","authorId":"3557887424829909","name":"aaffsmcjje","avatar":"https://static.tigerbbs.com/0fcb01cf792998a6ce47337ae22c20b9","vip":1,"crmLevel":2,"crmLevelSwitch":0},"htmlText":"There will be one. Anytime can happen. Big dogs will decide when only","listText":"There will be one. Anytime can happen. Big dogs will decide when only","text":"There will be one. Anytime can happen. Big dogs will decide when only","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":0,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/219806595514480","repostId":2367754489,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"}],"isCommentEnd":false,"newsSizeData":{"likeSize":7,"commentSize":0,"repostSize":1,"favoriteSize":2,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.5","shortVersion":"4.22.5","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2367754489"}