25 March 2019
Rising U.S. Recession Concerns
There is little doubt that your finances and investments matter to you, but emotional steadiness is essential to long-term success. The market environment can change quickly. Witness the last couple of weeks. Volatility surged (before quickly retreating) over growth concerns in the United States and much of the rest of the world. Although not quite to the same degree as what characterized last September’s market highs, attitudinal measures of investor sentiment had rebounded into the extreme optimism zone, reversing slightly during the first week in March. In fact, pessimism as per the American Association of Individual Investors is now at a six-week high. But the fledgling pickup in optimism has not been matched by behavioral measures of sentiment. The latest Commitment of Traders report showed limited buying by the largest cohorts of investors—including large and small speculators and commercial hedgers. We also know from Schwab data that retail fund flows have been anemic; suggesting that much of the juice for the rally has come from corporate stock buybacks, which are running at a record pace on an annualized basis.
We’ve also seen mirror image behavior this year with regard to equity multiples. This year, earnings expectations have steadily deteriorated; but thanks to looser financial conditions, multiples have actually expanded. We do believe there is a limit to continued multiple expansion and that earnings growth will likely have to exceed the lowered expectations bar for the market to generate significantly more upside. Consensus estimates for first quarter S&P 500 earnings are now in slight negative territory; with only 3% growth or so expected for the subsequent two quarters. This suggests the risk of an earnings recession is elevated, even if it occurs outside of an economic recession (like was the case from mid-2015 to mid-2016).
State of the economy
The pause in the rally seen earlier this month can be attributed to economic and earnings growth concerns and growing recession fears. According to The Washington Post, Google searches including the word “recession” recently hit their highest level since the Great Recession. Tied to that is the latest reading from the Atlanta Fed of their GDPNow forecaster, which has plunged to only an annualized 0.4% growth rate. Critically, the labor market continues to be tight; possibly a factor in the weak employment report for February. The Labor Department reported that only 20,000 non-farm payroll jobs were added in February, with the unemployment rate dropping to 3.8%. While the consumer continues to look fairly healthy, business optimism remains fairly subdued. For animal spirits, and capital spending, to revive, we believe a resolution to the outstanding trade disputes is needed.
Crouching inflation, hidden danger?
Along with hopes for a trade deal with China, we believe the recent shift of the Federal Reserve to a more dovish stance contributed to the year-to-date rally. But the aforementioned tightness in the labor market, which has led to a continued acceleration in wage growth, could begin to filter into traditional inflation measures—a mild risk we believe is underappreciated by the market.
Is Europe already in recession?
As noted, we don’t think inflation in the United States will run away, because there are continued deflationary pressures globally. The European Central Bank (ECB) lowered its 2019 forecast for Europe’s economic growth and inflation. But is the ECB behind the curve? Has Europe already slipped into a recession? Market-based measures have been pointing to heightened risk of a recession for some time now. German 10-year bond yields have fallen to near zero, signaling a weak outlook. Additionally, stocks in Europe have been tracking a similar pattern to that during the last European recession, which took place from mid-2011 to early-2013.
Yet, despite similar market reactions, the data shows that the economic downturn hasn’t been nearly as deep as in 2011-13. Economic growth still remains positive and running at a quarterly growth rate that is about 0.4% higher (or 1.6% on an annualized quarterly basis) than during the 2011-2013 period. So far, this slowdown doesn’t appear to be a recession.
Recession fears have increased but first quarter growth weakness could be short-lived, as has often been the case with first quarters. We don’t see a recession in the near term, but believe trade policy remains a key factor in the span between now and the next recession. Economic and earnings growth risks have risen and the short-lived volatility spike we saw earlier this month could reemerge. Given late-cycle tendencies, we continue to recommend investors remain at or near their longer-term U.S. and global equity allocations, remain diversified, and use volatility for rebalancing opportunities.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.
Past performance is no guarantee of future results. Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
About the author:
Liz Ann Sonder, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist
Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research