An ongoing meltdown in U.S. stock prices, driven by pessimism about the economic outlook, is boosting the risk of a recession that arrives sooner than some professional forecasters anticipate, traders and investors say.
Falling equity prices have already contributed to the disappearance of $5 to $8 trillion in household wealth this year, and are now being accompanied by weaker corporate outlooks. Analysts cited a revenue and earnings warning from a single company, Snapchat parent Snap Inc. SNAP, -43.35%, as the main reason behind Tuesday’s rout in technology stocks, the S&P 500 index’s slide to near bear-market territory, and a flight to safety in government bonds.
Professional forecasters tend to speak about the risks of a U.S. recession in terms of one- to two-year horizons. Economists surveyed by The Wall Street Journal in April put the probability of a downturn over the next year at 28%, on average. Meanwhile, a May survey of 53 forecasters by the National Association for Business Economics shows the median expectation is for inflation-adjusted U.S. growth to slow to 1.8% year-over-year in the fourth quarter. More than half of respondents assigned a more than 25% chance of a recession occurring within the next 12 months.
What may not have been fully been factored into markets or forecasters’ views just yet is how quickly deteriorating financial conditions can affect the day-to-day to decisions made by companies and spill over into the economy. The list of companies that have already moved to curtail hiring include Facebook’s parent Meta FB, -8.43%, Twitter Inc. TWTR, -5.71%, and Uber Technologies Inc. UBER, -9.54%, chip maker Nvidia NVDA, -4.85%, and Salesforce Inc. CRM, -2.35%. Meanwhile, streaming giant Netflix Inc. NFLX, -4.69%, Carvana CVNA, -13.79%, and PayPal Holdings Inc. PYPL, -3.71% have cut jobs.
“The impact of financial markets, in many ways, contributed to the situation of an overheating economy and rising prices,” said Mark Heppenstall, chief investment officer of Penn Mutual Asset Management, which manages more than $33 billion from Horsham, Pa. “Falling asset prices will work in the opposite way: the evaporating wealth effect and psychological impact of what markets are telling people can tend to spiral.
“Slowing growth is almost certainly in the cards and the steeper the falloff in asset prices, the increasing odds of a recession happening sooner rather than later,” he said via phone. It was a dynamic also seen in the 2008 financial crisis, which stemmed from a “confluence of events, but part of the equation had to do with a total evaporation of liquidity in the markets and a huge bear market in equities.”
U.S. data released on Tuesday showed that new home sales plunged in April and businesses expanded at the slowest pace in months. However, other recent data suggested the American consumer is still healthy, with retail sales solid last month, but optimism was quickly extinguished by earnings misses from retailers such as Target Corp. TGT, -2.83%.
The U.S. economy shrank 1.4% during the first quarter, a contraction chalked up to a record U.S. international trade deficit, following a 6.9% surge in GDP in the final three months of 2021. The National Bureau of Economic Research defines a recession as a significant decline in activity lasting more than a few months, which can make it hard to see when one has already started.
“The previous thinking in markets had been that inflation and the Fed’s fight to end it would be what gets us into a recession,” said Rob Daly, director of fixed income for Glenmede Investment Management in Philadelphia, which oversees about $4.5 billion in fixed income assets. “But it’s the repricing in markets now that could lead us to recession by slowing growth. Those chances are definitely increasing probably every day.”
Though he sees a U.S. growth slowdown morphing into the potential for a “light recession” at the end of 2023, Daly said “the fear is that it could creep onto our doorsteps quicker. I don’t want to seem like I’m underwriting a recession, but there’s certainly a lot of things that are out there that can cause the economy to slow.”
The list of downside risks plaguing financial markets and the economy includes: inflation running at a four-decade high, approaching Federal Reserve interest rate hikes, Russia’s war in Ukraine, supply-chain disruptions, China’s COVID-19 lockdowns, and the resurgence of more U.S. coronavirus cases.
Earlier this year, investors were grappling with valuation problems as the Fed began raising interest rates from almost zero, leading to a correction in asset prices, according to Glenmede’s Daly.
Now, the market is “starting to see the potential that inflation won’t be controlled as quickly as we would hope, and that maneuvers by central banks — not just the Fed — are going to squash growth, which could push us down faster than we thought,” Daly said via phone. “The bond market is pricing in this lower growth scenario and is taking some of its cues from the stock market, without necessarily signaling what it thinks about how much the Fed will hike rates anymore.”
As of Tuesday afternoon, a rally in bonds pushed Treasury yields down by 10 to 15 points each, leaving the 10-year TMUBMUSD10Y, 2.758% below 2.74%. Meanwhile, the Nasdaq Composite Index COMP, -2.79% fell 2.6%, or by more than Dow industrials DJIA, -0.17% and the S&P 500 SPX, -1.18%.
With so many investors positioned for brighter economic growth prospects for so long, the unwinding of those trades at the same time is creating more market pain. Funds invested in equity long/short strategies worldwide are all in the red for the year, according to a performance review compiled by HSBC’s alternative investment group.
The group of hedge fund managers known as Tiger Cubs, which crowded into tech stocks, are getting clobbered. And Melvin Capital, which took a bath on GameStop and meme stocks and was forced to liquidate, was seen as one possible reason for last Wednesday’s broad-based stock selloff that led to the Dow and S&P 500’s worst daily plunges in about two years.
“The economy is slowing and likely slowing pretty dramatically,” said Gregory Faranello, head of U.S. rates at broker-dealer AmeriVet Securities in New York.
“Could we dip into a recession quicker than people anticipated? The answer is yes, but we’re going to need more time to see the data,” he said. “It’s not that we’re rooting for that, but we’ve had very dramatic repricing across the board in a short period of time, and that’s going to hit the economy. We’re starting to see signs of that.”