Why the recession is important to investors

There is some confusion about a) what a recession is and b) why it is important. Sometimes, the ideas that we think are obvious are granted and the general issues become the subject of disagreement. When this happens, we go back to the first principles to explain what these problems mean and why they are significant.

Investors are concerned about the recession because economic contraction shrinks employment, lowers consumer and business spending, reduces corporate revenue and ultimately negatively affects profits. The last item for investors is: Low income.

Although there are numerous theories about stock market prices, they seem to come down to some combination of the two items: Profit and market their multiple allocations.

Earnings are reported quarterly, but that is constantly determined by multiple investor psychology. The price / earnings ratio (P / E) fluctuates over time, so Price = Earnings X Multiple Is not fixed. This is why the recession can cause a double whammy: income is declining as psychology becomes more negative. The net result of both is to bring down the overall stock market price.

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This simple fact is why we are in a technological recession or not – And I think “no” – Much less important than whether economic activity is shrinking – in particular, whether corporate and household costs are declining.

Let’s take a look at the specifics:

The National Bureau of Economic Research (NBER) determined the start and end of the recession.1 Official arbitration of such things in the United States Even if you use a general rule such as two negative quarters of real GDP, what is important to investors is the key driver: Income And Multiply the market. When the economy expands, but we get two negative GDP prints anyway, it doesn’t matter. In the present case, we have volatile movements in trade and inventory that are not a camouflage of measurement, a reflection of an economic contraction that affects corporate revenues or profits. At least, so far so good.

Put aside the possibility of Q1 and Q2 negative real GDP. Consider what the U.S. economy has done in the first two quarters of 2022:

Jobs: 2.74 million new jobs created;

Wages: 5.1% y / y for all workers, 6.4% for low paid workers

Consumer costs: Increased 4% year on year

Corporate profit: Profits increased significantly by 10.6% in Q1 and Q2 from last year; The 2022 forecast expects companies in the S&P 500 to increase their full-year profits by 10.6%.

Home sales: The biggest downside to the economy is a red hot housing market is cooling; Existing home sales fell 3.4% in May, the fourth consecutive month that sales have declined. Generally, we see sales increase from low January to July / August. Prices have risen due to a lack of inventory, but rising mortgage rates are now a drag.

In a relatively healthy economy, the problem is not the decline in economic activity, but the fact that inflation causes problematic price increases.

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If the economy is right then why the market has come down so much? One reason is the average return – much higher than the average 8% market return in the last two years 2020 + 21% and 2021 + 28%. Another reason is the elimination of very cheap credit and very low capital costs. This could ultimately affect corporate profits.

The war against the Fed Inflation Much of the blame (or credit) goes for the rising rate, but it was too late for the Federal Reserve to move away from its emergency position and move to a historically normal rate. With the benefit of insight, Fed Chairman Jerome Powell now realizes that it should have started before 2021. Despite CPI inflation being at a 40-year high, the Fed has an excuse to end both the zero-interest rate (ZIRP) and quantitative easing. (QE) policy.

The key question for investors is a potential policy flaw: will the Fed implement this plan properly? Could they be the cause of the growth slowdown – cooling the economy enough to end inflation – but not causing a complete recession? Or will they overwrite and cause real economic contraction?

My position is that we are probably past the highest inflation, most of the inflation we have seen is beyond the control of the Fed, and they no longer need to raise rates aggressively. Instead, they should move more slowly towards normalization. 13 June CPI reportM We could provide some signal if we are going to see a 50bps or 75 bps rate increase.

The answer to our title question is earnings, since how FOMC can affect earnings, investors have three questions left:

1. Will the FOMC recognize high inflation and moderate its tight cycle?

2. Will they get another 75 points? AgainIs a full-blown recession risky?

3. How much does it already cost in the equity market?

We get hints of our next inflation when the consumer price index is released on Wednesday 13 July; The next FOMC meeting is July 27 + 28.

Previously:
Reviewing the highest inflation (June 29, 2022)

Who is responsible for inflation, 1-15 (June 28, 2022)

Many Bears (May 3, 2022)

Unilateral Market (September 29, 2021)

See more:

The Biggest Argument for Money Now (Wealth of Common Sense, July 9, 2022)

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1. The National Bureau of Economic Research’s definition of recession is “a significant decline in economic activity that spreads to the economy and which lasts for more than a few months.”

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