After more than a year of back-and-forth debate over whether the world’s largest economy could slip into a downturn, investors are settling into the surprising conclusion that the U.S. can manage to dodge one.
Friday’s data showed the Federal Reserve’s favorite inflation measure, the personal consumption expenditures index, eased in June on an annual basis to an almost two-year low. That followed Thursday’s stronger-than-expected second-quarter GDP report — which was accompanied by a decline in jobless benefit claims last week, a jump in durable-goods orders last month, and the real-estate industry’s declaration that the housing recession is over. All of this is translating into more optimism than previously seen during the current cycle.
Stocks DJIA, +0.50% SPX, +0.99% COMP, +1.90% finished higher in response to the data on Friday, bouncing back from a lower finish on Thursday that had been triggered by a report about the Bank of Japan. Even after the Federal Reserve pushed interest rates to a 22-year high of between 5.25%-5.5% on Wednesday, investors seem to be increasingly on board with Chairman Jerome Powell’s view that “we do have a shot” at a soft landing for the economy, albeit with the caveats that “it is a long way from assured” and “we have a lot left to go to see that happen.”
Optimism initially emerged two weeks ago when June’s consumer price index showed the annual headline rate of inflation easing to 3% versus a 9.1% peak a year earlier.
“The math is now soft landing or no landing, at least that’s how the markets are going to treat this,” said Phil Toews, chief executive of Toews Asset Management in New York. “It feels like just a great, great time for bulls. The combination of an unexpectedly benign CPI number, a good GDP report, still-strong employment, and a strong consumer is adding up to a realization that we may not have a recession. That is the most important ‘new’ news and takes the key bear argument off the table.”
Many in financial markets began the year assuming that the Fed’s ongoing war on inflation and rapid series of interest rate hikes since March 2022 would drive the economy into a recession, technically defined as a significant decline in activity that lasts for more than a few months. Instead, the U.S. proved to be surprisingly resilient, despite more than five full percentage points of Fed rate hikes, the most recent of which was delivered on Wednesday.
One of the most historically accurate strategies for identifying primary trends in stocks, known as the Dow Theory, has been pointing toward the likelihood of a broadening bull market. Meanwhile, Carol Schleif, chief investment officer of the BMO Family Office in Minneapolis and Chicago-based economists at Stifel, Nicolaus & Co. said Thursday’s GDP report is stoking optimism about a soft landing scenario in the U.S., even after the fastest interest-rate increases in four decades.
On the flip side of the debate, Ali Hassan, portfolio manager at Thornburg Investment Management in Santa Fe, N.M., with $42 billion in client assets as of June, said he still fears that the Fed will hike the U.S. into a downturn.
Toews of Toews Asset Management said in a phone interview that “at the very least you had to be concerned about the possibility of a recession and we certainly were. In April, once we got beyond the regional-bank issues, we saw the need to make sure that customers got equity allocation. Everyone is waking up to the reality of an almost 20% S&P 500 gain year-to-date versus a 5% T-bill rate, and trillions of dollars that have been cautious now may be deciding to come into the market.”
The market’s optimism is reflected in the most recent reading of the American Association of Individual Investors, which showed that bullish sentiment among individual investors reached 44.9% for the week that ended on Wednesday, above the historical average of 37.5%. It’s the eighth straight week in which optimism has been above average. However, Brent Schutte, chief investment officer of the Northwestern Mutual Wealth Management Co., notes that “abnormally high readings such as these often precede negative equity returns over the following 12 months.”
For William Davies, global chief investment officer at Boston-based Columbia Threadneedle Investments, which managed $617 billion in assets as of June, the question of whether there will or won’t be a U.S. recession remains unsettled. Via phone on Thursday from London, he said “the debate is still open” and “the jury is still out, given the tightness of the labor market.”
“The question is, ‘can inflation go back up?’ We expect that it’s not going to come down as quickly as people think, unless the unemployment rate rises,” Davies told MarketWatch. Columbia Threadneedle is in the camp that expects the fed funds rate target to reach 5.5%-5.75% and stay there well into 2024, he said, adding that his firm favors high-quality investment-grade credit and thinks equities “can probably go higher” given more resilient earnings than some had feared.
“Our view is we might get a recession or lackluster growth, but it really doesn’t matter,” Davies said. “The big thing is that we don’t get a sharp recession like we did in 2020 or the early 2000s. As we go through the year, the data has been stronger than many had feared and the view that there might even be a mild recession may have been too pessimistic. Maybe we get just slowish growth.”