The Data Says Recession, But the Market Doesn't. Which Is Right?
As I write, the Core PCE Index numbers, the Fed’s preferred measure of real underlying inflation, have just been released, showing a higher-than-expected rise in prices. It is too early to say how the market will respond as we close out the week, although the immediate reaction was muted at best.
I do know one thing: Based on what we have seen so far this week, the market reaction to these data won’t make sense to a lot of people. We now have 9.1% headline inflation, core CPE at more than double the Fed’s target rate, and a shrinking economy. That sounds a lot like the dreaded stagflation of the 70s and 80s to me, and yet as the data comes in and as the Fed raises rates that shrink the economy, the market moves higher.
What on Earth is going on?
I used to look forward to economic data. I know that sounds a bit nerdy, but you have to understand that I worked in dealing rooms for a long time, where “the figures” meant we tensely waited in the minutes leading up to the release of the numbers, then experienced adrenaline-inducing mayhem immediately after. News results in movement and, in the trading world, movement results in money.
I say I "used to" for a reason, though. Maybe it is just that I am old and looking back with the kind of rose-tinted glasses that we old people tend to wear, but it seems to me that back then, numbers were a lot easier to interpret, a lot less confusing. Right now, the fun has gone out of the figures.
So far this week, we have seen a Fed decision that involved a second consecutive 0.75 point rate hike, and a GDP print that showed a second consecutive quarter of shrinkage in the U.S. economy. On the surface, both of those are bad news for stocks. “Rate hikes bad” is the most basic thing traders are taught, and for a long time, two consecutive quarters of negative GDP growth were considered to be the rule of thumb for a recession. However, when both bad news hit the wire, the market cheered, and stocks soared on both days.
There were oft-quoted reasons given to explain both reactions but honestly, they sound more like excuses than reasons. For the Fed’s decision, it was “At least they didn’t hike a full point!”, which obscures the fact that short-term rates have gone up one and a half full points in a month, and that the yield curve is now inverted in a very worrying way. The GDP numbers are explained by simply moving the goalposts. The same people who were telling us a while back not to worry about a recession because we hadn’t had two consecutive quarters of a shrinking economy are now telling us that actually, a recession only comes when the government tells us it does.
That is true, of course. More accurately, a recession comes only when the National Bureau of Economic Research’s (NBER) Business Cycle Dating Committee says it does. They are the body that told us what we already knew back in 2008/9, and again in 2020 after the world’s economy shut down completely. They are the referees of the recession game, but what we are seeing now is beginning to feel like watching an edge rusher clearly grab a quarterback’s facemask, then looking around in vain for a flag. The foul happened, but it wasn’t a foul because the refs didn’t call it. The difference with NBER committee’s decisions, though, is that fouls are called well after the fact, using backward-looking data as a kind of slow-motion replay.
I get it, in some ways: unemployment is at record lows, and wages and consumer spending are rising, so it doesn’t “feel” like a normal recession. That is because it isn’t normal. Nothing in the post-pandemic world is normal, but who says a recession has to be normal? We can have a business recession without it yet affecting workers and consumers, and that is what we seem to be in. The key word there, though, is "yet." It might or might not spread and start to look like a traditional recession, but should that matter? We have high inflation and a shrinking economy right now, which is beginning to negatively impact corporate profits. So, I am not cheering this recent news.
However, the market is. As I write this, twenty minutes after the release of figures that core CPE rose more than expected, S&P 500 futures are trading around three points lower than immediately before the numbers. That is a drop of less than one tenth of a percent in stock prices, after data showing that the Fed’s rate hikes to this point aren’t slowing down inflation. That presumably means more hikes to come, even as the economy shrinks. If current trends continue, it is only a matter of time before the rest of the data start to catch up and, when that happens, the foul will be seen by the NBER and called, even though the game will be over by then.
To stretch the sports analogy a bit, I don’t want to bet on a game where the refs only make calls when all the players are back in the locker room. That is why I am using this rally to take small profits on some things that I bought a month or two ago, when the numbers looked a bit more promising, and waiting for another leg down before deploying the cash. I am a numbers guy, and the numbers say that the economy is in bad shape, not just here in the U.S., but around the world. That is good enough for me to sit on my hands for a bit, no matter what the talking heads and NBER are saying.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.