The Bill Comes Due
These are no doubt uncertain times for the United States economy. With many claiming that a major recession is inevitable, and just as many countering with optimism, there is no clear answer to the immediate trajectory of the economy and the financial markets. One can only hope to assess the data available and make the most educated decision possible. This article will cover some of the largest factors to take into consideration and address areas of concern, as well as reasons to remain hopeful.
What is a Recession?:
Before prematurely diagnosing the U.S. with an impending recession, it’s important to understand what exactly constitutes one. According to the National Bureau of Economic Research, an economic recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. Should the former be unknown or not provide a clear answer, one can look for certain indicators and events that have historically preceded a recession such as the inverted yield curve which has successfully predicted 9 recessions since 1955, and the FED’s monetary policy where out of the last 13 rate hikes, 10 came right before a recession.
Current Challenges in the Economy:
There are a number of present macroeconomic concerns as U.S. GDP shrinks, oil and energy costs rise, inflation is at a staggering 8.54%, and supply chain issues are getting worse as the bullwhip effect persists in conjunction with the developments in Ukraine and China. Another concern for many is the ratio of home price to median income which illustrates that the current level is far beyond the peak of 2008 which could be a sign of another real estate bubble about to pop (Longtermtrends, 2022). The FED’s response to these matters has been to stop the purchase of bonds, which has been propping up the economy, reduce its balance sheet which effectively destroys the stimulus money loaned, and raise interest rates all in an effort to try to mitigate inflation (Cox, 2021). However, should inflation continue to rise in conjunction with a decrease in spending and high unemployment, the U.S. could see stagflation for the first time since the 1970s which would be devastating for the economy.
Long Term Debt Cycles:
Given the aggressive bull market rally reaching new highs soon after the Covid-19 recession and the severity of the current issues the U.S. faces, it is possible that the long-term debt cycle has finally caught up. These cycles are longer than the average recessionary/growth cycles which typically occur every 7 years. Instead, they occur roughly every 50-75 years and typically begin and end when there is large-scale restructuring of the current financial system (Metheny, 2022). The falling portion of the long-term debt cycle consists of a debt burst, followed by printing money and extending debt, and finally debt and political restructuring. The U.S. national debt hit record levels exceeding 27.8 trillion in the fourth quarter of 2020 and subsequently printed money that took rates to zero. It’s a possibility that the U.S. restructures its debt as economic stress continues. The last restructuring happened in 1945 at the end of World War II with the establishment of the Bretton Woods monetary system and it has been 77 years since, which would lead people such as Ray Dalio, billionaire investor, hedge fund manager, and predictor of the 2008 crash, to believe that we are due for one in the very near future.
Market Psychology and the New Trading Philosophy:
Something worth addressing is how the financial markets have responded in the past and how market psychology has changed since then. Looking back to the housing crisis, the crash took 1 year and 5 months to bottom out and 5 years and 5 months to get back to all-time highs. During the pandemic, the stock market crash lasted just 35 days and took only 6 months to recover back to previous highs. It is true that the housing crisis was more of an underlying and internal financial issue than the Covid recession but this is less about the underlying causes of the recession and more about the choices people are making. Do not forget that during Covid-19, businesses were forcibly closed, travel was restricted, lockdowns were imposed, unemployment skyrocketed, the supply chain was disrupted, and thousands of people were dying per day. It could be argued that citizens were given every reason to keep cash on hand and save yet people were pouring money into the markets. A study done by Schwab shows that a staggering 15% of their total current investors joined the platform during the pandemic (Fitzgerald, 2021). Moreover, the fundamental principles that once governed the stock market seem to no longer exist as we have moved into a highly irrational market that completely misunderstands what investing is. This is likely due to the perception changes of what constitutes a good company and the fundamental catalysts that impact it. Investing was once driven on the basis of valuation so if there was a company that was determined to be trading below fair value, it was a good investment regardless of whether the price drops in the short term. However, as technology allows more and more people to invest with little to no knowledge of the financial markets, it has become a get-rich-quick scheme as new investors know little more than to buy the dip without even understanding why it dipped or what the company does. This new style of trading could be best described as trading the price, not the company as new investors look for a dip and naturally assume it will return to highs with no knowledge or estimates of true intrinsic value. This has brought a great deal of volatility to the markets as inexperienced investors are quick to buy and even quicker to sell. The fear of missing out on gains (FOMO) has triggered massive moves for individual equities and the market as a whole. Bottom line, it's impossible to determine how the markets will react and how this new train of thought will affect the financial markets in the near future. There are two rules one needs to be aware of to understand this new climate: First and foremost, every reaction is an overreaction, and second, the only certainty in the market is uncertainty.
Is There Still Hope?
Yes, as history has proven over and over, the economy will eventually stabilize and the stock market will push to new heights. For investors, the real question that needs to be asked is how much more will it fall and how long will it take to recover which are much more difficult to answer. If you are hoping for a recovery like the one during the pandemic, you will likely be disappointed. Given the severity of the issues the U.S. economy currently faces and the fact that there is no immediate solution, it is probable that the markets will take much longer to recover as rather than injecting money into the economy, the FED is withdrawing it. Despite the fact that a recession seems reasonable at this point in time, further analysis of the data determining GDP illuminates some contradictory information. Ben Casselman, a business journalist for the NYT points out that the negative GDP in the first quarter was a result of a decrease in inventories and trade and a decrease in government spending for Covid-19 relief efforts. The decrease in inventory and trade is due to the fact that companies previously built up very strong inventories in light of the pent-up consumer demand and supply chain issues but are now ordering less as they still have a stockpile of goods leading some to believe that the underlying economy is still strong. Looking at consumer spending (the engine of the U.S. economy), business investment, and residential investment, its clear to see that the key domestic demand components are actually strong as they increased in the first quarter despite soaring gas prices and the Omicron wave of the coronavirus, which restrained spending on restaurants, travel, and similar services in January (Casselman, 2022). So yes, there is reason to believe the markets could begin to recover relatively soon but as mentioned previously, no one can ever be 100% certain and it’s best to prepare for the worst.
*Edited by Andy Colando
Works Cited
Casselman, B. (2022, April 28). U.S. economy shrank in first quarter, but underlying measures were solid. The New York Times. Retrieved May 14, 2022, from https://www.nytimes.com/2022/04/28/business/economy/us-gdp-q1-2022.html
Cox, J. (2021, December 15). Fed will aggressively dial back its bond buying, sees three rate hikes next year. CNBC. Retrieved May 14, 2022, from https://www.cnbc.com/2021/12/15/fed-will-aggressively-dial-back-its-monthly-bond-buying-sees-three-rate-hikes-next-year.html#:~:text=The%20Fed%20will%20be%20buying,the%20reduction%20further%20come%202022.
Cox, J. (2022, April 28). U.S. GDP fell at a 1.4% pace to start the year as pandemic recovery takes a hit. CNBC. Retrieved May 14, 2022, from https://www.cnbc.com/2022/04/28/us-q1-gdp-growth.html#:~:text=Investing%20Club-,U.S.%20GDP%20fell%20at%20a%201.4%25%20pace%20to%20start%20the,pandemic%20recovery%20takes%20a%20hit&text=Gross%20domestic%20product%20in%20the,trade%20imbalance%20weighed%20on%20growth.
Frank, S. (2022, January 31). Home price to income ratio (US & UK). Longtermtrends. Retrieved May 14, 2022, from https://www.longtermtrends.net/home-price-median-annual-income-ratio/
Metheny, N. (2022). Wealthrise Capital. Retrieved May 12, 2022, from https://www.wealthrisecapital.com/insights/endgame-is-a-name-depicting-the-end-of-this-most-recent
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Sweeny, E. (2022, January 19). The big challenges for supply chains in 2022. World Economic Forum. Retrieved May 14, 2022, from https://www.weforum.org/agenda/2022/01/challenges-supply-chains-covid19-2022
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Fitzgerald, M. (2021, August 18). A large chunk of the retail investing crowd started during the pandemic, Schwab survey shows. CNBC. Retrieved May 31, 2022, from https://www.cnbc.com/2021/04/08/a-large-chunk-of-the-retail-investing-crowd-got-their-start-during-the-pandemic-schwab-survey-shows.html
