If Taylor Swift’s Eras Tour is any indicator, maybe the economy is headed for a soft landing. Swift’s tour tickets were the hot item this summer, with prices ranging from hundreds to thousands of dollars. While the massive success of this tour is just one data point, it’s notable that thousands of people do not feel like the economy is slowing and have the disposable income available to spend on her concerts. Maybe it’s still a “YOLO” (you only live once) effect from Covid, as consumers continue to spend lavishly on experiences like concerts and travel, but the fact remains that consumers are not behaving like a recession is imminent.
Spending and sentiment have remained resilient despite the Fed’s monetary policy tightening actions to try to contain inflation. Continued labor market strength and decelerating inflation reports have added to market participants’ confidence that we will have a soft landing (i.e., a mild recession) or no landing (no recession) even though the Fed has hiked the Fed Funds rate 11 times since March 2022. The target rate is now 5.25%-5.5%, an increase of over 500bps in just over a year.
Current market expectations are for the Fed to be nearing the end of its interest rate hikes. Projections now are for one more hike in September and then a pause, depending on how inflation data and economic growth are trending. Many market participants think the pause will be short-lived, and the Fed will start cutting rates next year. Monetary policy tightening typically takes some time to slow the economy, but in this case the negative effects have been limited. Are we all just shaking off warning signs?
It’s been a strong year so far in the equity markets despite the weakness in August, however it’s in these more exuberant times in the market that negative signals can be overlooked. Below are a few features of today’s markets investors should have on their radar screens:
- Inverted U.S. Treasury yield curve: a yield curve plots fixed income, or debt securities of a specific borrower across maturities. Typically, the yield curve slopes up and to the right, as investors demand more return the longer the security is outstanding. Today, the yield curve for U.S. Treasury securities is inverted, meaning that short-term Treasuries are yielding more than long-term. An inverted curve can mean that long-term bond investors expect a recession, and previous inverted curves have preceded recessions by 18-24 months.
- Continued pressure on financial institutions: while the bank runs and failures of February and March seem long ago, financial institutions remain under pressure. Banks are paying out higher rates on deposits to retain customers and have increased their capital cushions in anticipation of tougher regulations coming. Earlier this month, Moody’s, a credit rating agency, downgraded the ratings of numerous regional banks and is reviewing others for potential downgrades on asset quality concerns, particularly if there is a recession. Lower ratings increase funding costs for banks, as investors demand additional compensation for increased risks.
- Lackluster corporate earnings in Q2 2023: 84% of companies in the S&P 500 have reported quarterly results for Q2 2023. The year-over-year earnings decline is -5.2%. Companies that have reported positive earnings surprises (i.e., better than expected results) have on average had negative stock price reactions. Earnings growth for the overall S&P Index are expected to grow just 1% in calendar year 2023, according to Factset.[1]
Looking forward to the rest of 2023 and into 2024, there are major positives to today’s environment, including a resilient job market, strong consumption trends, less interest rate sensitivity in the overall economy, and decelerating inflation. We also appear to have successfully exited the very easy monetary policy regime put in place after the Global Financial Crisis and the Covid-19 market crash. Actually having a soft landing, or no landing, would be an incredible feat, however there are some underlying risks which market participants appear to be underappreciating, creating additional risk. It’s important to recognize trouble when it walks in, so that market volatility doesn’t take us off guard. That way should there be a sell-off, we’re able to focus on buying great stocks at great prices.
[1] Factset Earnings Insight, August 4, 2023, https://insight.factset.com/sp-500-companies-see-largest-negative-price-reaction-to-positive-eps-surprises-since-2011
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