Why Recession Is Still Likely (and when)

Editor’s Note: The S&P has been down sharply for the past two months. Inflation has returned, with oil now at $90 and prices rising at the pump. Interest rates remain high and are going higher. And that’s putting pressure on asset prices. Earlier this month, I broke down the current macro picture for members of Foundational Profits. You can see some of that analysis below. We have sidestepped the losses of the past two months and have been profiting in non-traditional ways. To see our current portfolio, get the full issue here. 


I saw a recent poll of market participants about their outlook for the stock market for the remainder of the year.

A third were bullish. A third were bearish. A third were neutral.

It’s easy to see why people are so confused. The data and price action has been confusing for  the duration of our last trip around the sun.

Economic growth has been low and continues to stagnate while the stock market moves higher.

Oil’s going up while copper’s going sideways.

Consumer sentiment is near 2008 levels, yet they keep on consuming with retail sales remaining relatively strong.

The data of late has no bounds to how much it confounds, making our job separating the signal from the noise particularly challenging.

Yet separate we must, and separate we have.

This letter has been largely bearish since December 2021, when we last sold out of the energy sector and began positioning more defensively.

It was the right move.

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We handily beat the market with our closed portfolio in 2021, selling our long oil and long tech positions. Yes, we were long tech in 2021! No permabears here.

We beat the market again last year, selling the bullish run in gold and uranium in the first half the year while they were running hot and the mouthbreathers were talking about “going to the moon.” Both the precious metal and uranium complexes finished the year much lower.

This year, as mentioned, has been more difficult, but our conviction is poised to compound. We’re still above water when accounting for all positions, though the price action on the S&P has stayed stronger for longer than I expected it to.

August saw stock price action more in line with the economic reality that I’m seeing in the data. It was the stock market’s worst month since February.

Where did Goldilocks go?

She’s probably out climbing the hills left by the dollar and short-term bond yields, which have sped significantly higher since mid-July.

the dollar and short-term bond yields, which sped significantly higher since mid-July.

Those are big short-term moves for such large asset classes.

What does it mean?

It means the Fed’s not done hiking yet, which I’ve been saying for over a year now.

Investors — perhaps a third of them — who’ve failed to break the zero-interest Pavlovian response to buy the dip made out ok this year. But the current downside risk in the S&P is greater than its upside potential, and they are now truly picking up pennies in front of a steamroller.

We have previously discussed in these pages the recessionary cascade of H.O.P.E. — housing, orders, profits, employment — as a general order of the way things break heading into an economic slowdown or recession. It was developed by Michael Kanrowitz at Piper Sandler.

H.O.P.E. — housing, orders, profits, employment.

Housing already broke and is now trying to deal with our current “new normal” high interest rates. Mortgage rates for 30-years are now near 8%, up 165% from the 3% we knew for so long. This killed housing affordability and the refinance market. People with 3% mortgages simply aren’t willing to sell as it means they would have to take on a higher-interest loan to move. This has pushed would-be buyers into new homes, which has been great for the homebuilders. But the negative outcomes outweigh higher share prices for homebuilders. The grinding to a halt of the refinance market will have compounding and lagging effects on the economy as home equity is the main way Americans finance their consumption. What of those who can’t afford to build a new home? You can increasingly find them living in cars and tent cities.

Orders, too, have collapsed as the Institute for Supply Management's New Orders Index has fallen for eleven straight months and remains contractionary.

Profits. What profits? For the second quarter, S&P 500 companies reported a year-over-year earnings decline of -4.1%, according to FactSet.

For the second quarter, S&P 500 companies reported a year-over-year earnings decline of -4.1%, according to FactSet.

And that leaves employment, which, as most people know, has remained “relatively strong.” Until recently. July JOLTS job openings fell to 8.8 million from 9.2 million in June. And that 9.2 million was revised down from 9.6 million. According to the August Challenger report:

U.S.-based employers announced 75,151 cuts in August, a 217% increase from the 23,697 cuts announced one month prior. It is 267% higher than the 20,485 cuts announced in the same month in 2022, according to a report from global outplacement and business and executive coaching firm Challenger, Gray & Christmas, Inc.

ADP data for August was similarly sour. It showed that private employers added 177,000 jobs in August, which was below consensus estimates and much lower than July’s additions of 371,000 jobs added.

Non-farm payrolls continue to beat expectations on the initial report, adding 187,000 jobs in August, but the June and July numbers have since been revised sharply lower. June was revised lower by 80,000 to 105,000, making that the smallest monthly gain since December 2020. And the July estimate moved down by 30,000 to 157,000.

Like the economy itself, employment has an order to how it breaks down. Temp work is the first to be cut. Then overtime hours. And then pink slips.

Right on cue, Reuters was out this month with a report titled, “Fewer US temp jobs may flag longer lasting concern,” that noted:

A steady drop in the temporary worker employment is a concerning blight in an otherwise steady U.S. labor market. Despite adding another 187,000 jobs in August, short-term positions such as event staff declined for a seventh consecutive month, to about 2.9 million, according to data released on Friday by the Bureau of Labor Statistics. The trend has been an ominous sign before.

Companies that recruit and place temps tend to cut payrolls when the first signs of an economic slowdown emerge. Employment in the sector peaked 11 months before the 2000 and 2007 recessions, per BLS data. The crest, at 3.2 million, occurred 17 months ago, in March 2022, signaling that weakness could be ahead.

Reuters was out this month with a report titled, “Fewer US temp jobs may flag longer lasting concern.”

So where does that leave us in Macroland?

It leaves us still with a higher chance of recession than not.

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The current quarter (Q3) will see positive economic growth, but will get dangerously close to flat or negative growth in Q4 of this year and the first two quarters of next year.

There will likely be no rate hike from the Fed this month as the market is currently pricing in only a 7% chance of one. In November that probability rises to 43.5%. And I would suspect with inflation back on the rise, thanks largely to crude oil prices rising 25% in the past month, that we get that hike. Surely you’ve noticed the rising prices at the pump. Expect 3% to 3.5% inflation over the next few quarters, which will keep the Fed hawkish or else risk losing its credibility even more than it already has.

Why Recession Is Still Likely (and when)

Slow growth with reinflation is a classic stagflation scenario.

Credit will come under pressure, particularly in the commercial real estate space, which will tighten lending in general and put further pressure on the regional banks that we haven’t heard from in a few months.

We’ll see if one more Fed hike is enough to get the recession they so desperately want and need.

And whether or not that comes with a stock market crash is not the point. The point is that the risks outweigh the upside in the broader markets, and so we remain overall bearish and defensive.

But that doesn’t mean we’re entirely out of the markets. We recently sold a well-known tobacco company for double-digit gains. We’re long gold and select gold stocks. Our uranium and lithium positions have been performing well. And we’re long India in a way most wouldn’t think of. 

You can get the full issue to see all our holdings and reports here. 

Nick Hodge

Nick Hodge
Publisher, Daily Profit Cycle