
Through the end of last week, the S&P 500 index fell by 23.4% from its January 2022 record high peak. The index moved into bear market territory after the Federal Reserve (the Fed) voted to raise rates by 0.75% at its June meeting. Jerome Powell, chairman of the Fed, reiterated that they are committed to cooling inflation, and are willing to accept lower growth and higher unemployment targets to counter it. Inflation fears that had turned into a growth scare have now seemingly turned into a recession obsession. Today, we discuss why we believe this is a slowdown in the US and not a recession.
US Consumer
The University of Michigan Consumer Sentiment Index is at its lowest point ever. Consumers are pessimistic. Probably due to the fact that all they hear about is the risk of recession, with a daily reminder of inflationary pressures when they fill up the car at the pump. On top of this, the stock market is now at year-to-date lows, which makes things worse. However, we believe the situation is not as bad as it looks.
True, the US just had its first quarter of negative growth (-1.5%) since the pandemic in 2020, but the data behind this is more solid than it appears. Economists are suggesting that the negative growth is coming from a correction post-Covid, due to a trade deficit and firms trimming their inventories. Consumer spending is actually growing, income is rising in the US, and it is not due to an increase of debt.
Source: Bureau of Labor Statistics of Federal Reserve Bank of Atlanta
In fact, credit card debt, as a percentage of total debt, is currently at a 20-year low and Americans are seeing wages rise, especially low earners. Inflation is still having a negative impact on these gains, but the Fed estimates that once the rate of inflation falls below 6% (currently at 8.6% year on year), real wage gains could be restored.
US Outlook
Last year’s 5.7% GDP growth rate was not sustainable. This was mainly supported by Biden’s spending plan and the accommodative Fed. US growth had to slow down this year and it has come back to “normal” levels of around 2% per year. This is similar to US GDP growth of around 2.1% per year for the decade prior to Covid.
Another positive sign are the business surveys published on a monthly basis, such as the ISM Manufacturing and Services PMI. Even if they have recently deteriorated, especially compared to last year, they are still far from levels seen during previous recessions.
Finally, it is true the spread that high-yield borrowers must pay above government borrowing costs has widened. The gap has recently reached the 5% premium mark, which is the historical average for the US. However, it is still well below the 7.5% that we see in advance of a typical recession. This is a signal to watch out for if the gap continues to grow.
US High Yield Borrowing Costs vs Government Bonds
Source: TradingView; Index: 1m ICE BofA US High Yield Index Option-Adjusted Spread
Overall, the odds for a recession have risen, especially due to the spike in interest rates, but we do not feel we are there yet. Some investors and the media can give the impression that the current situation is worse than in 2008, when actually the economic landscape today is healthier. Within our diversified portfolios we have held exposures to defensive equities that have performed well when compared to wider indices containing big names. We have also slightly increased our cash exposure across portfolios, ready to re-deploy when opportunities arise.