The anticipation of a U.S. economic recession, which might seem counterintuitive at first, could, in fact, avert a significant market downturn in the latter half of 2023.
Michael Yoshikami, the founder and CEO of Destination Wealth Management, presents this interesting viewpoint. This article investigates the rationale behind Yoshikami’s prediction and the broader market implications.
Counterintuitive as it may seem: A potential recession as the market’s lifeline
Consumer price inflation in the U.S. reduced to 4.9% on a yearly basis in April, the most sluggish annual pace since the same month the previous year.
This latest data from the Labor Department was widely received as an encouraging indicator that the Federal Reserve’s strategic measures to control inflation are making progress.
However, the core Consumer Price Index (CPI), which doesn’t account for variable food and energy prices, exhibited a 5.5% increase annually in April. This happened against the backdrop of a robust economy and a persistently strained labor market.
Despite the CPI witnessing a substantial cool-off since it hit an apex of 9% in June 2022, it continues to hover significantly above the Fed’s 2% target.
The Federal Reserve, steadfast in its commitment to combat inflation, convened the Federal Open Market Committee, where officials had varied perspectives about the course of interest rates.
They ultimately opted for an additional 25 basis point rise, placing the target federal funds rate between 5% and 5.25%.
A U.S. recession’s positive influence on the market
Yoshikami, in a recent discussion on CNBC’s “Squawk Box Europe,” pointed out that a potential recession might be beneficial for the market.
According to him, if economic growth in the U.S. doesn’t slow down or even if a shallow recession doesn’t materialize, it might be perceived as a disadvantage. The rationale is that interest rates might not be cut or could even escalate in such a scenario, posing a risk for the market.
With the expectation of borrowing costs remaining high for an extended period, Yoshikami predicts that numerous companies will start to guide the market more conservatively concerning forward earnings, thereby mitigating their profit margins.
While it may seem paradoxical, Yoshikami suggests that a near-recession state of the economy could be construed as positive news. He forewarns that if the economy continues on its frothy trajectory and sidesteps recession, it could lead to market problems in the second half of the year.
Officials from the Federal Reserve, including St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari, recently signaled that persistent core inflation could result in a protracted tight monetary policy, which could necessitate more rate hikes this year.
Yoshikami urges investors to exercise caution with market valuations, particularly in the tech and artificial intelligence sectors, in light of the uncertain future of U.S. monetary policy and the economy.
He encourages investors to carefully assess the reasonability of a stock in the context of projected earnings over the next five years. Otherwise, they might be attributing an unjustified optimism premium to the asset, leading to potential disappointment.
Through this detailed exploration, we uncover a unique perspective on how an anticipated U.S. recession could serve as a lifeline for markets in 2023.
This scenario provides an interesting counter-narrative to the conventional understanding of recessions and their impact on markets. The key takeaway is the importance of nuanced market understanding in an increasingly complex and interconnected global economy.