There’s a certain sense of dread among economists and pundits that a recession’s coming around the corner. Probably a bear market too. Analysts have stuck their finger in the wind and said consumer demand is softening, and that 2023 earnings are likely to suffer as a result. (This week, J.P. Morgan cut its 2023 earnings forecast for the S&P 500 by 9%, Reuters reported.) The Federal Reserve’s desire to fight inflation with higher interest rates has most people thinking that a hard landing recession is unavoidable.
But is it?
A few strategists at Natixis Investment Managers said yesterday that the sense of dread may be overstated.
In a webinar the firm hosted titled “Outlook or Look Out!” three of the firm’s market watchers weighed in on what the economic data say about a recession. The Natixis team looked at everything from the pockets of the American economy where inflation was still rearing its ugly head to Americans’ pent up savings and the still tight labor market. Looking closer, they found incongruities, ambiguities and anomalies. For instance, there was a lot of cash savings in consumers’ bank accounts, housing costs set to fall, some goods deflation and lower credit card delinquencies. There was also a lot of corporate debt not coming due, and the labor market that could be rattled by an influx of new job seekers (and thus softer wages).
Another takeaway was that consumer growth has been resilient if you look closer at sectors like home improvement, autos and aircraft.
“Everybody thinks that a recession is inevitable,” said Natixis portfolio strategist Garrett Melson. “That brings up an interesting point. If everybody thinks it’s already coming and has thought [that] all year, you’ve really seen companies start to batten down the hatches. And now you’re starting to see that the economy is actually more resilient. Inflation is starting to fade away. The pressure for more rate hikes [could start] to fade. Well, if that recession does not materialize, now you’re way too far off-sides in terms of battening down the hatches, and it opens up the potential for pro-cyclical self-fulfilling prophecy that really is going to be helpful for a positive feedback loop on growth.”
Portfolio manager Jack Janasiewicz said that the bears are calling for a deep recession, but said that might be misguided given the backdrop. Why? Because deep recessions are usually the result of businesses being caught off guard: When they aren’t ready for it, their inventories are bloated. They’ve produced too much. They are overleveraged. “I would argue we’re very far away from that backdrop today. And as a result, maybe things are in a much better place than people are giving it credit for,” he said.
Janasiewicz and Melson said that corporate and household balance sheets are in good shape. They also said that real core retail sales, which, unlike the nominal sales, don’t take inflation into account, have been flat until recently but are starting to bend upward.
“The composition of growth is starting to shift much more favorably back away from the price side and inflation and back towards real growth, which is exactly what you want to see,” Melson said.
The housing market is another area where there are a lot of bright spots that nobody is catching, the Natixis managers said, and that’s because the Federal Reserve’s inflationary tactics have had swift effect in real estate.
Melson said: “You’re back to 2012 levels essentially on existing home sales, 2017 levels on new home sales, mortgage apps essentially undercutting their lows from the financial crisis and back to 1995 levels. So for all intents and purposes the housing market has essentially been broken here. … You can’t break it twice. If you see rates tick back higher over 7%, it’s not going to have the same effect as the first time that happened. What you’ve seen is mortgage rates have come off about 100 basis points in about a three week window and you’ve seen actual mortgage applications start to pick back up. That suggests there’s a lot of demand on the sidelines should rates start to soften up [and] that’s going to come back on the residential side.”
He also said that home owners aren’t moving but instead are sitting on low-rate mortgages and choosing to spend on their money to upgrade what they have. “Renovation and remodeling activity has really ramped up," he said. "You’ve seen that home improvement consumption or construction spending is up on the order of almost 35% year over year."
When it comes to employment, there’s another subtlety that people are missing, say the Natixis team: the supply side of the labor market. Though the labor market is tight, and wages are sticky because of hiring problems and skill mismatches, a lot of people have stayed out of the workforce, many because of Covid-19 and the problems it’s caused for them or their family members. Janasiewicz said that, when the employment to population ratio of those age 15 to 64 is counted, there are some 6.4 million people missing from the pre-pandemic picture.
“Where are all these people?” he asked. “And if want to think about the idea of bringing supply back up … you then are probably going to start to see competition picking up and hence wages coming down.”