The S&P 500 Index has declined by approximately 15% since the beginning of the year. The tech-heavy NASDAQ is down by more than 25%. These drops have caused some of our clients to wonder whether a recession lies ahead. In this short piece, we will give you our view of where the economy stands today, the risks it faces, and the probability of recession.
The economy is in good shape.
Notwithstanding the drop in stock prices, by most measures, the U.S. economy continues to perform well. Employers have created more than 400,000 jobs each month and would hire even more if they could. Consumers are flush with cash and have paid down debt during the pandemic, and are now spending at a brisk pace. Businesses are increasing production to meet strong demand, and are reporting good earnings. The average company in the S&P 500 reported more than 9% growth in earnings in the first quarter.
“The US Leading Economic Indicators rose again in March despite headwinds from the war in Ukraine,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “This broad-based improvement signals economic growth is likely to continue through 2022 despite volatile stock prices and weakening business and consumer expectations. The Conference Board projects 3.0 percent year-over-year US GDP growth in 2022, which is slower than the 5.6 percent pace of 2021, but still well above pre-covid trend.
If the economy seems strong, why are stocks doing so poorly?
Inflation, interest rates, and downward momentum seem to be the primary culprits. Inflation began to accelerate last year because manufacturers could not increase capacity fast enough to meet consumer demand. This drove prices up. When Russia invaded Ukraine on February 24th, shortages of oil and gas, grains, metals, and other commodities made inflation worse and lengthened the time it is expected to be a problem. Because of this, the Federal Reserve Bank has begun to aggressively tighten monetary policy by raising interest rates and withdrawing liquidity from the economy. Additionally, Millennials and members of Gen Z have never experienced interest rates or inflation this high. This has caused a lot of fear-driven selling by both institutional and retail investors. Slides in stock prices generate their own momentum, as selling begets more selling. Investors have a natural recency bias, a tendency to believe that recent experiences that are freshest in their memory are likely to continue. Even though consumers are flush with cash, consumer sentiment has taken a proverbial nosedive:
What are the odds of a recession?
In a recent survey of economists, experts placed the odds of a recession at 28%, or about 1 in 4. This risk is relatively low, but it has effectively doubled since the beginning of the year. With businesses and consumers in good financial shape we may avoid a recession, but if one occurs it is likely to be mild.
What about a market recovery?
Stock price declines of the magnitude we’ve seen this year are usually sharp and tend to reverse quickly. At the beginning of the pandemic stock prices fell dramatically, but within weeks turned around and began to recover. Within months the market indexes were again at new highs. These moves are impossible to anticipate and are therefore gut wrenching for investors. But the adage that the market cannot be consistently timed has always been true. Investors are usually left poorer when they sell into a sharply declining market because they miss part or all of the recovery. The annualized 3-year return of the Russell 1000 through May 11th is 10.5%, far in excess of its 8% long-term average. So, the recent pull back simply reflects giving up a little of the great returns from 2021 and has provided us with an opportunity to buy investments at a more attractive price.
As difficult as this market is, take solace from the fact that we have been through this before, and that the darkness of prior declines has always ultimately been followed by the light of recovery. We are fortunate that stock returns have been strong enough over the past few years that even with this decline and the decline during the pandemic, stocks have still averaged more than 10% a year.
 Zacks Research May 12, 2022
 Wall Street Journal, April 10, 2022.
 Orion Advisor Services Performance Reporting System