Is America In A Recession?

By Gargi Pal Chaudhuri

Transcript

This year, the Federal Reserve raised interest rates for the first time since 2018.

But what do these rate hikes mean for investors and the broader market? Let’s talk about it.

Factors such as worker shortages, rising wages, and supply chain woes pushed inflation to a 40-year high. People have felt it in the price of everything from a dozen eggs to a gallon of gas. Raising interest rates is one way the Federal Reserve fights inflation.

At their core, these rate increases make it more expensive to borrow money, whether it’s for a home, car, or personal business loan.

Making loans more expensive may encourage people and businesses to be more selective in their spending and investments.

This can help bring down prices and combat inflation, but it can also mean economic growth may slow down, which can contribute to market volatility.

While the Federal Reserve manages this balancing act, investors can consider a rebalancing of their own.

Investors might consider dedicating a portion of their portfolios to quality companies, those with stable cashflows and higher profit margins that can absorb or pass on higher prices.

To prepare for a potential slowdown in the economy, investors might want to also consider Minimum Volatility ETFs such as iShares MSCI USA Min Vol Factor ETF (USMV).

Most importantly, remember that market dips and spikes are part of normal, long-term cycles. And these small, progressive steps may be a possible solution to help investors – and the market itself – return to normal in the long run.

Key Takeaways

• The U.S. economy has slowed for two consecutive quarters, does that mean we’re already in a recession?
• Our Recession Monitor is flashing pink in two of its five categories. That’s cause for concern, but not necessarily indicative of imminent recession.
• The risks of recession are rising as U.S. economic data softens. Slowing periods of growth could favor fixed-income, value stocks, and minimum volatility strategies.

The economy shrank 0.9% in the second quarter vs. the prior year, the second consecutive drop in quarterly U.S. GDP. So, are we in a recession?

We think the answer is ‘not yet’. Our own recession deck (see below) shows 2 of 5 indicators are flashing pink; but not all 5. Still, the risks of a recession have risen as U.S. economic data is softening.

BlackRock Recession Monitor: Signs of Weakness, But Not Recession (Yet)

Consistent with the advanced second quarter GDP report, our recession monitor flashes pink for corporate health, but shows a strong consumer and still fairly easy credit conditions. Economic indicators such as real income, spending, and the labor market are certainly not yet showing the broad-based decline historically associated with a recession.

That said, second quarter GDP fell 0.9%, well below expectations of a modest rise, following a 1.6% decline in the first quarter. Drivers of the second quarter drop were:¹

1. A plunge in inventory investments as retailers are sitting on unsold goods. (Earlier this week, the world’s-largest retailer said they are reducing prices across discretionary goods as inventories increase.)²
2. A decline in residential investment given less home building
3. A drop in non-residential structure investment, showing that office segments continue to struggle with expansion plans – especially in a stalling growth environment.

The Federal Reserve acknowledged the slowdown Wednesday – “real indicators of spending and production have softened,” the FOMC’s policy statement said – even as it issued another 75-basis point rate hike.

What Is A Recession, Anyway?

Although “two consecutive negative quarters” is commonly used, ultimately, there isn’t one best definition of a recession. There are different ways to measure economic activity and the rules-based “consecutive negative quarters” approach can miss nuances. The National Bureau of Economic Research (NBER) is the official arbiter of U.S. recessions; the NBER uses a qualitative approach, which is more subjective.

We are currently in such an atypical cycle that we are more inclined to favor a qualitative approach to a recession call, be it the NBER’s or our own recession monitor. That’s especially relevant today as first cuts of GDP often get revised, something Fed Chairman Jay Powell stressed in a press conference after the Fed’s rate hike.

In this environment, we think it is important to remain invested in the markets but recognize that volatility may remain higher, as detailed in the iShares Mid-Year 2022 Investor Guide.

Ultimately, we believe the Federal Reserve – which has raised the target Fed Funds rate from 0-0.25% in the start of 2022 to 2.25-2.5% now – will need to slow their pace of rate hikes if economic activity continues to stall. The market is currently pricing in for rates to rise to over 3% by the end of 2022 before moving lower in 2023 to support a slowing economy.³

Slowing periods of growth may favor fixed-income allocations; a weakening dollar, which will likely result from a slower pace of rates hikes, may favor emerging market bonds. Within equities, strategies that focus on minimum volatility and companies with healthier balance sheets may fair better than the broader market.

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© 2022 BlackRock, Inc. All rights reserved.

¹ Source: BlackRock, U.S. Bureau of Economic Analysis, Advanced Estimate 2Q GDP Report, July 28, 2022.

² Source: Walmart Inc. Provides Update for Second Quarter and Fiscal Year 2023, July 25, 2022.

³ Source: CME Group FedWatch Tool, as of July 28, 2022.

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This post originally appeared on the iShares Market Insights.

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.