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

Federal Reserve Chairman Jerome Powell’s upbeat comments on the U.S. economy on Wednesday fueled a debate among investors over whether stocks have bottomed in the bear market.

On the one hand, Thursday’s report on the health of the US economy sparked even more confusing talk about the current state of recession.

Second-quarter GDP data, which showed the US economy shrank 0.9% on an annualized basis in the three-month period from April to June, heightened fears that the economy could has already slipped into recession.

See: Is the United States currently in a recession? Not yet – and here’s why

In contrast, the S&P 500 SPX,
+1.42%
officially entered bearish territory in mid-June and cemented its worst first-half performance since 1970, a sign that many investors have priced in an economic downturn.

The consumer price index for June, which reached 9.1%, added to the malaise, a high of 41 years. It was followed on Friday by the release of the Fed’s favorite monthly inflation gauge, the Personal Consumer Price Index, which offered no respite from price pressures at a four-decade high.

But the view that the Fed may need to “pivot” away from its full slate of rate hikes scheduled through 2023, if economic conditions deteriorate, has gained traction on Wall. Street, helping major stock indexes in July book their best month in nearly two years.

The strong performance of equities and other parts of the credit markets in July has led to a torrent of views heading into August, telling investors why this strategy looks flawed or not.

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

“When you want to signal the ‘everything is clear,’ that number has to be higher — 80 or 90%. That’s when we all know if we’ve hit bottom,” Horneman told MarketWatch during from a follow-up call Friday. “That’s why I’m not convinced the bottom is completely done. I think there’s a chance for a lot more volatility.”

Lily: All you’re feeling about stocks right now is normal bear market grief – and the worst is yet to come

Are we in a recession?

The central bank was careful to remind people that just two quarters of negative growth doesn’t automatically mean the economy is in recession, but one could still be “almost a slam dunk over the next 12 months,” Jim wrote. Reid, a strategist at Deutsche Bank, in a Thursday note.

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

SOURCE: BEA, NBER, HAVER ANALYTICS, DEUTSCHE BANK

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

Either way, there were bright spots for households as inflation squeezed paychecks. Wages and salaries for civilian workers rose 1.4% in the second quarter and 5.3% in the year ending June, according to data from the U.S. Bureau of Labor Statistics on Friday. A closely watched economic data point next week will be Friday’s July jobs report. A robust June report fueled optimism that recession could still be averted.

U.S. Treasury Secretary Janet Yellen said on Thursday the economy had weakened but was still healthy in many ways compared to previous downturns. She said some economic downturn is needed to help fight inflation.

What Profits Show: Consumer Spending

Consumer spending has long been a key driver of the US economy, with profits from companies like Apple Inc. AAPL,
+3.28%
and Amazon AMZN,
+10.36%
this week rejoicing investors, even as inflation ripples through the economy.

Bryan Perry, senior director at Navellier & Associates, said “one theme continues to emerge among major companies reporting their numbers – demand for their goods and services is healthy,” in a Friday note, adding that trucking , railroad, airline and accommodation companies reported strong demand.

Through Friday morning, nearly half of S&P 500 companies had posted a blended earnings growth rate of 7.6%, with 76% beating Wall Street forecasts, according to I/B/E/S data. provided by Refinitiv.

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

Horneman told investors to look at 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 the majority of the downside risk,” Horneman said.

To kick off August, Friday’s nonfarm payrolls will be a highly anticipated economic data point for the week. But before that, the ISM manufacturing index and the final reading of the manufacturing PMI are due on Monday. Tuesday brings the June job openings and leaves the data.

The three main US stock market indices posted their best monthly gains in July. The S&P 500 SPX Large Cap Benchmark,
+1.42%
ended Friday up 1%, while the Dow Jones Industrial Average rose 1.4%, helping the two 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 strongest monthly advance since April 2020.

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