There Are Many Signs A Recession Is Coming

seekingalpha07-26

S&P 500 hits all-time high, but concerns of potential headwinds, recession, and market correction prompt caution.The Fed's history of being behind the curve raises doubts about rate cuts and potential...

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I see a number of potential headwinds coming towards the market and July is historically a positive month, which means it could make sense to take some chips off the table this month. After July, we will be rapidly approaching a seasonally less favorable time of the year for stocks, such as September and October. Aside from these seasonal issues, we have the U.S. Presidential elections coming up, which could add volatility toward the end of the year. But these might all be relatively smaller issues when compared to my concerns about a recession coming. While the market is now near all-time highs, and many investors are excited about the potential for rate cuts starting in September, I am not so bullish. First, I think the market has already priced in the expectations for the Federal Reserve to cut rates in September. If I am right, this could create a \"sell on the news\" event, whereby the stock market actually drops after the Fed cuts rates, potentially in September. When I look at the chart of the SPY, it looks over-extended and toppy to me, which is another reason why I am raising cash levels and being tactical about any new stock purchases. StockCharts.com There are two ways to view the rate cuts: The bullish view is that rate cuts are going to happen soon because the Fed has conquered inflation and rate cuts will take some pressure off the consumer and a number of interest rate sensitive industries, such as real estate. I can appreciate that bullish view, and it could happen, in particular, if the Fed successfully pulls off the desired \"soft-landing\". However, I am concerned about the bearish view, which is that the Fed has already waited too long to cut rates and that the lag time of all these past rate hikes are finally going to catch up with the consumer and the economy as a whole and lead us to a recession. The Fed Has A History Of Being Behind The Curve It was not that long ago when the Federal Reserve was telling us that inflation was \"transitory\". There were many signs that the very low interest rates created by the Fed were fueling rampant speculation in stocks, Bitcoin, real estate, and other assets. It was obvious that huge overbidding wars in real estate were pushing up housing costs, and food costs were surging at that time as well. By the time the Fed admitted that inflation was not transitory, the genie was already out of the bottle and the Fed had to play catch-up to combat inflation by raising rates very aggressively. Just as there was a significant lag time for the full inflationary impact of the Fed's extremely low interest rate policy to be felt by the economy, I believe there is an equally long and powerful lag time for the full impact of the Fed's unprecedented interest rate hikes to be felt. I see too many warning signs that the Fed's aggressive \"catch-up\" rate hikes and its apparent belief in a higher for longer interest rate policy, is already creating issues that will not easily be reversed with a simple rate cut later this year. I believe that the Fed is repeating the same patterns now as it did when it waited so long to hike rates in order to combat what were obviously rising inflationary pressures. Furthermore, I think the Fed has waited too long again-in this case by not lowering rates already, and I believe by the time it does wholeheartedly decide to cut rates, we could be in a recession. I see too many warning signals right now of a potential recession, and I believe that the lag effect of the high rates has not been fully felt yet. By the time the Fed potentially cuts rates later this year, I believe the market could start to acknowledge that the Fed is not cutting rates simply because inflation has dropped, but because the U.S. consumer and the economy have cracked and tipped into a recession. Again, I want to stress the importance of the lag effect in this rate hiking cycle, in particular, because this was the second-quickest tightening cycle in recent history. Because of the speed of this monetary tightening, I believe the economy has not felt the full impact yet. However, I believe that it will soon, and only after it is already too late to create a soft landing. The Fed says it is \"data dependent\" and I believe therein lies the problem because by the time the data shows that the Fed's inflation goals have been met, it will likely be too late due to the lag effect. I believe the Fed needed to anticipate inflation before it got out of hand, and I also now believe the Fed needs to anticipate the increasing odds of a recession before it happens. Desmond Lachman of the American Enterprise Institute has published a very interesting article titled \"The Fed Keeps Making The Same Mistakes\", which details the impact of the policy errors that the Federal Reserve has made throughout the years as well as the risks he sees now from the current higher for longer interest rate policy. The article states:  \"Once again, the Fed seems to be ignoring - at its own peril - the dramatic recent swing in money supply growth from one of excessive expansion to one of contraction. Whereas in 2021 the broad money supply surged by over 10 percent, today it's actually declining at its fastest since the 2008-2009 Great Economic Recession. This should be raising red flags that the Fed is now engaging in monetary policy overkill to regain inflation control. That could bring on an unnecessary recession. With its past poor monetary policy record that led to multi-decade inflation, one might have hoped for a humbler and nimbler Fed. Instead, we have a Fed that keeps insisting that it might need to raise interest rates further and keep them high until at least 2024 to get inflation under control. It does so even when there are signs that the economy is slowing and inflation is moderating. For this reason, we might need to brace ourselves for a hard economic landing.\"  A Fed Pivot On Rates Often Results In A Market Correction While the market has rallied in recent months, based in part on the hopes of a Fed pivot on interest rates, the fact is that the market historically often drops after the first rate cuts. I want to point to a very interesting article by Meeder Investments which shows that historically, the market often experiences a large decline after the first rate cuts, and that the Fed often misses the mark in terms of job market losses that tend to come right around or soon after the first Fed rate cuts. If history repeats and the Fed underestimates unemployment by 2.5%, we could be seeing unemployment hit 7%, instead of the Fed's forecast of about 4.5%. The article states: \"Many investors believe the stock market will perform well after the Fed starts cutting interest rates. History tells us this is not necessarily true. Since 1970, more than half of the Fed's first cuts were followed by declines of more than -20% by the S&P 500 Index. Soft landings are easier said than done. Historically during recessions, the Fed underestimates the increase in unemployment by 2.5%.\" The Consumer Appears To Be Cracking And The Job Market Could Be Next The consumer is a huge driver of the U.S. economy. Recent data suggests that consumer spending accounts for nearly 70% of the gross domestic product, or \"GDP\" in the United States. That means that if the consumer is starting to crack, the U.S. economy could be next. There are already major warning signs that the economy is slowing down. Some consumers are under significant pressure now and this can be seen by looking at the increased delinquencies with auto loans as well as record high levels of credit card debt. What's notable to me is that a large number of consumers appear to be cracking now and that is happening when unemployment levels are relatively low at 4.1%; but as shown below, it has been increasing. If it goes beyond the levels projected by the Fed, we could see bigger cutbacks in consumer spending. Source: Bureau of Labor Statistics, U.S. Department of Labor I See Too Many Warning Signs Coming From Economically Sensitive Stocks I have been watching a number of economically sensitive and consumer spending-sensitive stocks, and I feel there are too many signals from these types of stocks that a potential recession is coming. Starbucks Corporation (SBUX) recently warned that consumers seem to be feeling the pinch, and its stock has been under pressure this year. Other consumer discretionary stocks have also been declining, even as the market hits new highs, much of which has been fueled by AI and mega-cap tech stock gains. Some of the stocks I have been watching as examples include Polaris Inc. (PII), Whirlpool Corporation (WHR), and more. These stocks cover a wide range of industries and they are all experiencing declines. When I look at the charts below, it shows me a level of economic weakness that could be a major sign of an impending recession. Even the high-end consumer appears to be cutting back, as LVMH Moët Hennessy - Louis Vuitton, Société Européenne (OTCPK:LVMUY) recently reported weaker than expected results, and this stock is now trading near 52-week lows. StockCharts.com StockCharts.com StockCharts.comStockCharts.com How I Could Be Wrong I could be wrong if the Fed is not too late with rate cuts, and there still is potential for the Fed to cut rates and create a soft landing. There is a chance that if the Fed cuts rates in September, it will boost consumer sentiment and spending enough to get the economy growing at a higher rate. This could take the recession scenario off the table. There is another unprecedented factor that I see as potentially mitigating any policy errors that the Federal Reserve might be making, and that is AI. I believe that it is possible that a boom in AI could create enough growth and positive sentiment to offset some or all of the slowdown that we appear to be seeing in the economy. In Summary The Fed has made policy errors in the past, and history shows that contrary to what many investors seem to be expecting, the first Fed rate cuts are often followed by a market correction. The Fed has also historically underestimated peak unemployment rates that occur with some lag time, after a major monetary tightening cycle, as we have just experienced. We are getting into a seasonally less favorable time of year for stocks, and the upcoming election might also cause volatility. There are many stocks that have been very weak this year and could be signaling that a recession is coming. With the S&P 500 Index and many other market averages appearing overextended now after a big rally, this could be an ideal time to raise cash. This is what I have been doing, and if the market declines after the first rate cuts or for other reasons, I will be in a position to deploy that cash when potentially better buying opportunities arise. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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