How to Position Your Portfolio When the Fed and Stock Market Investors Differ on Recession Calls

Federal Reserve Chairman Jerome Powell’s optimistic comments about the economy of the united states on Wednesday added to a debate among investors about whether stocks have bottomed out in a bear market.

For one thing, Thursday’s report on the health of the US economy sparked even more confused discourse about where things really stand when it comes to a recession.

The GDP data for the second quarter, which showed the The US economy contracted 0.9% on an annualized basis in the three-month period from April to June, intensified fears that the economy may already have slipped into recession.

Watch: Is the United States in a recession now? Not yet, and this is whatY

On the other hand, the S&P 500 SPX,
+1.42%
It officially entered bear market territory in mid-June and cemented its worst first-half performance since 1970signs that many investors have been pricing in an economic downturn.

Adding to the malaise was the month of June consumer price index that came in especially hot at 9.1%, a maximum of 41 years. It was followed on Friday by the release of the Fed’s preferred monthly inflation gauge, the personal consumption price indexThat doesn’t provide a respite from price pressures in up to four decades.

But the view that the Fed may need to “turn around” and move away from its full list of planned rate hikes through 2023 if the economic outlook worsens has been gaining traction on Wall Street, helping major stock market benchmarks. . in July to book its best month in almost two years.

The strong performance of stocks and other parts of the credit markets in July has led to a torrent of views heading into August, which tells investors why the strategy seems flawedOr not.

“Looking at the moving averages at the stock level in the S&P 500, it would suggest that we are not out of the woods,” Megan Horneman, chief investment officer at Verdence Capital Advisors, said in a note to clients this week. “The S&P 500 just crossed above its 50 day moving average for the first time since April last week. However, only 55% of the stocks in the index are above that average.”

“When you want to indicate ‘all clear,’ that number needs to be higher: 80 or 90%. That’s when it’s clear to all of us if we’ve bottomed out,” Horneman told MarketWatch in a follow-up call on Friday. “That is why I am not convinced that the fund has been fully done. I think there is a possibility of a lot more volatility.”

Read: Whatever you’re feeling about stocks right now is normal bear market pain, and the worst is yet to come.

Are we in a recession?

The central bank has been at pains to remind people that just two quarters of negative growth doesn’t automatically mean the economy is in recession, but one could be “nearly a knockout blow over the next 12 months,” wrote Jim Reid, a Deutsche Bank strategist, in a note on Thursday.

Historical data suggests that since 1947 (see chart below), there have never been two successive negative quarterly GDP results without the National Bureau of Economic Research (NBER), the official documenter of US business cycles, define the period as a recession. “It’s been rare to have negative GDP quarters outside of a recession,” according to Reid.

SOURCE: BEA, NBER, HAVER ANALYTICS, DEUTSCHE BANK

From Horneman’s perspective, the US has technically already entered a recession after two quarters of declining growth.

Either way, there have been some bright spots for households as paychecks are slashed by inflation. Wages and salaries for civilian workers rose 1.4% in the second quarter and 5.3% for the year ending June, according to data from the US Bureau of Labor Statistics on Friday. A closely watched economic data point next week will be Friday employment report for July. A strong June report fueled optimism that a recession could still be averted.

US Treasury Secretary Janet Yellen said on Thursday the economy has weakened, but remains healthy by many measures compared to previous recessions. He said some slowdown in the economy is needed to help fight inflation.

What the Earnings Show: Consumer Spending

Consumer spending has long been a key driver of the US economy, with corporate earnings of the likes of Apple Inc.
AAPL,
+3.28%
and Amazon
AMZN,
+10.36%
this week bringing joy to investors, even as inflation ripples through the economy.

Bryan Perry, a senior director at Navellier & Associates, said in a Friday note that “one theme continues to emerge from the leading companies that have reported their numbers: demand for their goods and services is healthy,” adding that major trucks, railways, airlines and lodging companies have been reporting strong demand.

As of Friday morning, nearly half of S&P 500 companies had reported a combined earnings growth rate of 7.6%, 76% above Wall Street forecasts, according to data from I/ B/I/O provided by Refinitiv.

Perry also said that “a recession, at least one of any significance that will derail the stock market from violating its long-term uptrend line, seems less likely.”

Horneman has been telling investors to look for areas that seem to have priced in the most downside risk to start putting their dry powder to work.

“At this point, the market has priced in most of the downside risk,” Horneman said.

To kick off August, Friday’s Non-Farm Payroll will be a highly anticipated economic data for the week. But before that, the ISM manufacturing index and the final reading of the manufacturing PMI are due on Monday. Tuesday brings data on vacancies and resignations for June.

All three major US stock indices posted their best monthly gains in July. The benchmark S&P 500 SPX large-cap index,
+1.42%
ended Friday up 1%, while the Dow Jones Industrial Average rose 1.4%, helping both post their biggest monthly gains since November 2020, according to Dow Jones Market Data. The high-tech Nasdaq Composite COMP,
+1.88%
advanced 1.9% on Friday to reach its biggest monthly gain since April 2020.

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