Economic Weakness and Outside Catalysts

The labor market is slowly becoming more vulnerable, showing economic weakness. The unemployment rate, currently 4.3%, has been slowly climbing since bottoming out in April 2023 (3.4%). 

4.3% isn’t a terrible number or a fantastic number. There is no need to be alarmed yet, but the fact that this metric is rising isn’t fantastic news.

An economy can slip into a recession when it experiences a combination of underlying economic weakness and an external shock.

Underbelly of the Economy

Generally speaking, economic weakness includes factors like:

• Overvalued asset markets (e.g., the housing bubble of the early 2000s)
• High levels of corporate or consumer debt (2008 financial crisis)
• Fragile financial system (e.g., banks with high exposure to risky loans)
• The adoption of socialist-leaning policies (e.g., Argentina in the early 1900s)
• Aging population (Japan and Italy are great examples of this)

These factors alone can cause strain on the economy but might not be sufficient to trigger a full-blown recession. 

Right now, we are experiencing a weakening economy caused by elevated interest rates, inflationary pressures (especially on lower-income individuals), and geopolitical tensions. These are probably not enough to tip us into a recession, but they set the stage for an outside catalyst to push us over the edge.

Outside Recession Catalysts

The nature of an external shock is that it is almost always unexpected. This is why economists and market analysts can never predict the exact timing of a recession. 

A few examples:

• COVID-19 Pandemic (2020)
  • The U.S. economy was weak in early 2020 (many people forget this), and widespread COVID lockdowns, disruptions in supply chains, etc., plunged the economy into a sharp but short-lived recession.
• Global Financial Crisis (2008)
  • The U.S. economy was extremely weak, and the U.S. consumer was massively overleveraged. The collapse of Lehman Brothers, triggered by the bursting of the housing bubble, led to a credit crunch.
• Dot-Com Bubble (2000)
  • Tech stocks were in a massive bubble in the late 1990s and early 2000s. The market correction of these stocks (most had no earnings) triggered a recession in March 2001, which was exacerbated by the 9/11 terrorist attacks shortly afterward.
• 1990 Oil Price Shock
  • The Iraqi invasion of Kuwait in 1990 led to a sharp spike in oil prices, which caused the U.S. to enter a recession. 

So, Economic Weakness Ahead?

Because catalysts are unexpected, it is really, really hard to accurately predict when a recession will occur. Therefore, it doesn’t make sense to make drastic adjustments to your portfolio in anticipation of an event that you don’t know will or when it will happen.

Yes, inflation levels have come down. But the cumulative effect of years of inflation has taken its toll on the average consumer. 

I expect this trend to continue, even with the Fed likely to cut rates during its next meeting. The damage of higher-than-average inflation for the past few years, coupled with the lackluster wage growth, has taken its toll. People are feeling the pinch. 

As this economic weakness trend continues, understand that the economy is vulnerable. External shocks are not as long-tail (rare) as you might think. We just don’t know when they will happen and in what form. 

What Can You Do?

Regardless, you shouldn’t sell everything and sit in cash. I’ve seen a lot of people do this over the years, and the opportunity loss of missing multi-year market runs far outweighs any market correction they might’ve sidestepped. The data could be wrong, and this could be a false positive. It happens all the time. 

Furthermore, if/when a catalyst occurs, it could be months or years out. We just don’t know. With a more accommodative Fed and a fall interest rate environment, risk assets have plenty more room to run. You don’t want to be on the sidelines during a run like this. 

That being said, you should make sure that you are well-diversified and prepared for a recession if it were to happen. In my opinion, big-tech stocks are very much at risk. See my recent post on the AI market bubble here. 

If/when a market correction/crash occurs, take advantage of the discount and buy more, if you can. We do this at predetermined price levels for our clients as it is part of our investment philosophy. It is important to set your emotions aside and to behave rationally, especially when there is panic on the street. Your future self will thank you for the steady hand.

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