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Economic Soft Landing? Or a Head Fake

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Wow, we have witnessed an impressive market rebound over the past few months. The S&P 500 rallied +11.7% from 11/1 to 12/14, a hairs-breath away from an all-time high. The growth-oriented NASDAQ is up +12.7%, surpassing its all-time high. 

This, of course, came on the heels of the Federal Reserve pointing to easing conditions and a recession that has yet to materialize. 

On December 13th’s meeting, the Fed indicated that there will be no more interest rate hikes in the foreseeable future and (possibly) three rate cuts next year. This is fantastic news for investors all over the world. Time to break out the champagne and party like it’s 1999. 

So far, it appears that the impossible has happened – we are experiencing an economic soft landing. The Fed has somehow managed to stave off a recession while taming inflation. For all investors out there, this has been a best-case scenario for 2023. Inflation has fallen, people have kept their jobs, and the markets have recovered. I, for one, have welcomed these events with open arms. 

However, it is important to ask this very important question – are we in the clear? Is this economic soft landing sustainable, or is the inevitable slowdown just around the corner? 

Aggressive Rate Hikes

As a reminder, the Federal Reserve aggressively hiked interest rates from 0% to 5.25% over the past two years. This is the fastest series of rate hikes over the past 35 years.

If history has taught us anything, it’s that there is always a price to be paid. There are no free lunches in the world of economics. Remember that a recession almost always occurs shortly after the Fed hikes rates. 

Yet, the market is rallying as if we are in the clear. Perhaps we are, but there is a lot of conflicting data out there and it is difficult to simply ignore these facts. 

Tea Leaves Point to Weakness

Leading indicators are (still) pointing to a recession, which is set to begin sometime early next year.

The WLEI (Weekly Leading Economic Index) has turned positive over the past few weeks as this index is more sensitive to stock market performance. A market rally of 12% will do this. 

However, the Weekly Leading Superindex, which is a more robust indicator, is still in negative territory, signaling weakening economic conditions. 

Even the labor market, which has been extremely resilient, is beginning to show signs of weakness. The unemployment rate is impressively low at 3.7%. By all accounts, the labor is still strong. However, the labor market is a lagging indicator, meaning that this figure alone tells us nothing about what is to come. Labor is typically the last shoe to drop when an economy falters.

Labor Weakness

The single biggest driver of the unemployment rate is the number of new jobs the U.S. economy creates, which is outlined in the aptly named Jobs Growth Report.

Only a few know that the jobs growth indicator has cyclical aspects. The economy tends to add certain types of jobs during different periods of the economic cycle. More specifically, the U.S. economy tends to add education and health jobs late in the economic cycle while the growth rate of all other jobs tends to decline. And right now, we are seeing this happen. 

The job gains in the economy over the past few months have been in just these two industries. If you were to strip out health care, education, and hospitality, the private sector has actually lost jobs. 

There has also been a big decline in temporary job hiring. Typically, before a company resorts to layoffs, it’ll let go of temporary staff, often a leading indicator of a slowdown in the job market.

Time Will Tell

So, does this mean that this weakness will spread to other parts of the economy? We don’t know. Perhaps the economy is more resilient than any of us know. Perhaps the Federal Reserve hitting pause on the interest rate hikes will be enough to turn things around. 

Maybe this time really is different. However, it is a dangerous game to bet on it. 

Environments like this are exactly why one should stay invested and diversified. Don’t make a big bet either way, and be sure to follow the data. And right now, the data is saying that we are witnessing a gradual decline in economic activity. 

In this environment, it is important not to get caught up in the euphoria of the recent rally and to chase performance. We are rebalancing our clients’ portfolios and taking advantage of cheaper, smaller stocks that are likely to benefit from lower borrowing costs as the larger growth stocks (think Amazon, Apple, Tesla) are quite expensive (more on this topic another day). 

In the meantime, please feel free to reach out to us if you have any questions. We are more than happy to assist.

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