June 30 2023

The Recession Wolf That Never Came

As we’ve learned as kids, crying wolf for too long make people downplay the truthfulness of your calling. That’s precisely what’s happening after calling for a recession for the last 12 months. Rightly or wrongly, the market does not believe it will ever come to bite.

This week only, the US President downplayed the risk of a recession, banks were quick to pivot their recommendations, with JP Morgan seeing “scope for soft landing” and ditching its exposure on long-duration bonds. Lloyd Blankfein, ex-Goldman Sachs’ CEO, joined the “soft landing” club too.

Is it the FOMO bug biting everyone? Well, there is a bit of this. After an eye-watering ~15% rally on the S&P500, and some 40% on US tech stocks, cautious portfolio managers are feeling a bit silly, and clients start questioning their stance. The reality is that portfolios have to be positioned for the long-term, and the longer this rally goes, the worst the re-entry point in risk assets would be. Cash is cool at 5% return, but it’s not a long term strategy.

Today’s data highlights a reasonable economic cool down, albeit at a high level of strength. Disinflation is settling in across Europe and the US. Job market is resilient. Households consumption trades sideways, as savings are being replenished.

Bear with me, it doesn’t mean that the recession wolf will never come to bite, but that her teeth are a lot less sharp. In other words, the fear factor is lower and optimism is higher. A lot higher than a month ago.

Of course, central banks re-iterated in concert at a retreat in Portugal this week that interests should stay higher for longer. Their mission is not accomplished until inflation goes back to the 2% level. Their view is “data dependent”, which means “after the fact”, and the market bets that rates have peaked.

Happy days then? Mehhh, not quite. Equity valuations remain elevated and it’s enough reason to be cautious, as price forward a great deal of future growth. The growth may still materialize, but you pay for it today, therefore diminishing the prospect of future returns. In an on itself, it doesn’t mean that the market collapse is imminent, it means that it’s wise to locate the exits as Jay Kaeppel, sentiment trader in chief, says.

Wolf or not, the economy looks like it is in a good place for now, compared to the worst fears that built in toward 4Q22. Liquidity has dried up but remains elevated, as the Fed dialed back some of its QT to quell the banking crisis. Besides, huge piles of Money Market cash still sits on the sideline waiting to return to productive assets.

The situation is less drastic that it once was, but sentiment still feels out-of-touch with some economic realities, notably in housing.

Stay safe out there.