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Market Volatility
U.S. economy hit by rolling recession
Jared Franz
Economist
Chris Buchbinder
Equity Portfolio Manager
Pramod Atluri
Fixed Income Portfolio Manager

What happened to the widely predicted recession that was supposed to wreak havoc on the U.S. economy this year? It happened. Just not all at once.


Different sectors of the economy have experienced downturns at different times. Thanks to this rare case of a “rolling” recession, the U.S. may not experience a traditional recession at all this year, or next, even with the dual pressures of elevated inflation and high interest rates.


“I am increasingly seeing signs that we may not get a broad-based recession,” says Capital Group economist Jared Franz. “Instead, what we are getting are mini-recessions in various industries at various times without much synchronization.”


Different sectors have experienced downturns at different times

The image shows how rolling recessions have impacted travel, manufacturing, oil prices, chemical production, housing and semiconductors at various stages of the pandemic and over the following years. The TSA checkpoint travel numbers show that the number of monthly airline passengers declined by roughly 2 million between February and April of 2020, before gradually recovering over the following three years to reach 2.6 million in July 2023. In manufacturing, the U.S. ISM Manufacturing PMI Survey data shows the sector experiencing a sharp fall-off in the early stages of the pandemic, when the index declined by 15% between February and March of 2020 to a low of 41.8, before building back up to a peak level of 63.8 in March 2021, and then gradually declining for the next two years to a level of 46 as of June 2023. The WTI crude oil spot price shows a decline in 2020 around the start of the pandemic, falling from $45 per barrel in February 2020 to a low price of roughly $19 per barrel in April 2020, before gradually recovering to a peak price in May of 2022 of $115 per barrel, and moderately declining through most of 2023 to a price of $82 per barrel as of July 2023. The U.S. Industrial Production Index for Chemical Manufacturing shows a couple of sharp drops in production levels in the early part of the pandemic and through 2021, falling from an index level of 98 to 92 between February and March of 2020, and from 97 to 90 between January and February of 2021, before gradually recovering and maintaining relatively steady levels through 2023, to reach a level of 104 as of June 2023. The Philadelphia Stock Exchange Semiconductor Index shows a steady increase from 2019 to 2022, growing by roughly 210% between January 2019 and December 2021, followed by a sharp decline throughout most of 2022, falling by 42% between December 2021 and September 2022, before rebounding in 2023, growing by roughly 67% between September 2022 and July 2023. In housing, the U.S. S&P CoreLogic Case-Shiller 20-City Composite Home Price Index shows U.S. housing prices surged during the early part of the pandemic and continued to expand, consistently growing between 1 and 2% per month between May 2020 and June 2022, before turning negative in July 2022, hitting a low in August 2022, turning positive again in February 2023, and then growing consistently on a monthly basis through May 2023.

Sources: Travel: Capital Group, Transportation Security Agency (TSA), U.S. Department of Homeland Security. Data is a 30-day moving average. As of July 26, 2023. Semiconductors: Capital Group, Philadelphia Stock Exchange, Refinitiv Datastream. As of June 30, 2023. Data represents cumulative price return since January 1, 2019. Housing: Capital Group, Refinitiv Datastream, Standard & Poor's. Latest available monthly data is May 2023, as of July 27, 2023. Manufacturing: Capital Group, Institute for Supply Management (ISM), National Bureau of Economic Research. Refinitiv Datastream. Figures reflect the seasonally adjusted survey results from ISM's Manufacturing Purchasing Managers’ Index (PMI). A PMI reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining. As of June 30, 2023. Chemicals: Capital Group, U.S. Federal Reserve, Refinitiv Datastream. Data indexed to 100 in 2017. Figures are seasonally adjusted. As of June 30, 2023. Oil: Capital Group, Refinitiv. As of July 26,2023. Past results are not predictive of results in future periods.

Residential housing, for instance, contracted sharply last year after the U.S. Federal Reserve started aggressively raising interest rates. At one point in 2022, existing home sales tumbled nearly 40%.


“Now it looks like the housing market is starting to recover while other areas of the economy, such as commercial real estate, are beginning to spiral down,” Franz explains. “As more people work from home, the outlook for office real estate is particularly troublesome.”


Likewise, the semiconductor industry was plagued by broken supply chains and lower demand for computer chips in 2022. That sent semiconductor stocks plummeting. This year, the business has stabilized, demand has returned, and semiconductor stocks are driving a rally in the global equity markets.


Can a full-blown recession be avoided?


If these contractions and recoveries continue, Franz explains, we could wind up in an environment where U.S. gross domestic product does not turn negative at any point in 2023 or 2024, thus averting one of the most widely predicted recessions in history.


“I still think a short, mild downturn is possible,” Franz says. “But if consumer spending doesn’t crack, then this widely expected recession could be like the boogey man who frightened everyone but never showed up.”


Indeed, the federal government reported last week that the U.S. economy grew at an annual rate of 2.4% in the second quarter. That was well above consensus estimates and faster than the 2% rate in the first quarter. The surprisingly strong growth was driven by stable consumer spending and dramatically higher business investment, up 7.7% on an annual basis.


Consumer and business strength has also contributed to a red-hot labor market, with healthy job creation and an unemployment rate of 3.6%, near a 50-year low. “Recessions are nearly always associated with broad-based job losses,” Franz notes, “and we just aren’t seeing that right now.”


U.S. economy is bolstered by historically strong job market

The image shows a bar graph charting the U.S. unemployment rate and monthly changes in employment ranging from June 2021 to June 2023. The left vertical axis represents the U.S. unemployment rate in percentages from 3.0% to 6.5%. The right vertical axis represents the monthly change in nonfarm payroll employment in thousands from zero to 1,000. The image shows the unemployment rate went from roughly 6% in June 2021 to roughly 4% in June 2023. Of note is the period between December 2021 and June 2022 when the monthly change in nonfarm payroll employment was the highest at 900 and the U.S. unemployment rate was 4.0%.

Sources: Capital Group, Bureau of Labor Statistics, Refinitiv Datastream, U.S. Department of Labor. Figures are seasonally adjusted. As of June 30, 2023.

What about the inverted yield curve?


On the other side of the recession debate, many economists have argued that an inverted yield curve is the most reliable recession predictor that we have. Right now, the inverted yield curve — which happens when the yield on short-term bonds is higher than the yield on long-term bonds — appears to be screaming for a recession. And it has been for more than a year.


An inverted yield curve has preceded every U.S. recession over the past 50 years. The current yield environment is more inverted than it has been since the early 1980s. This powerful signal has convinced many economists and bond market investors that a recession is inevitable in the next year or two.


Could that view be wrong? Or at least a misreading of the bond market? Yes, says Pramod Atluri, principal investment officer of The Bond Fund of America®.


High inflation, which we also haven’t seen since the 1980s, is the key determining factor today, Atluri believes. Fed officials have made it clear that fighting inflation is their priority, and they appear to be achieving their goal of bringing prices back down to earth. Inflation fell to 3% in June from 9.1% a year ago, a remarkable decline in just 12 months.


That means Fed officials may be able to cut interest rates in the months ahead, not because they expect a recession, but because they are close to achieving their stated goal of 2% inflation.


Is an inverted yield curve no longer a reliable predictor of recessions?

The image is a line graph showing the difference between 10-year and two-year U.S. Treasury yields (basis points) between 1981 and July 2023. Recessions are represented by grey columns and values below zero (inverted yield curves) are represented by magenta dots. Historically, the graph shows that 2-year treasury bonds have been higher than 10-year bonds, while each recessionary period over this time frame has been preceded by an inverted yield curve. The yield curve was negative in April 1981, January 1989, February 2000, December 2005, August 2019, and July 2022.

Sources: Capital Group, Bloomberg Index Services Ltd., National Bureau of Economic Research, Refinitiv Datastream. As of July 26, 2023.

“An inverted yield curve means the market is predicting that the federal funds rate will be higher today and lower tomorrow. That’s it,” Atluri adds. “The yield curve is not predicting an impending recession. It is predicting that inflation will be lower in the future and, therefore, the Fed will be able to end its rate-hiking cycle.”


“As a corollary, if inflation gets back to 2%, then an inverted yield curve will once again be a good predictor of declining economic growth and rising recession risk,” Atluri concludes.


What are the investment implications of a soft landing?


Many investors have clearly been positioning their portfolios for a recession, as evidenced by a massive rotation into cash and cash equivalents over the past two years. As of June 30, assets held in such conservative investments surpassed $5.4 trillion, according to the Investment Company Institute.


But what if a recession is replaced by a soft landing? What opportunities does that present to investors who are willing to venture out a bit on the risk spectrum?


“Earlier this year, I was very concerned about a recession,” says Chris Buchbinder, a portfolio manager with The Growth Fund of America®. “But I have eased off that expectation and, in my view, I’d say the probability now is below 50%.”


That view has led Buchbinder to consider investing in companies that are traditionally impacted by recession worries but have proven to be resilient — particularly in the post-pandemic recovery period. Pent-up demand has benefited many companies in the travel and leisure industry, for instance, as well as aerospace and aviation, as Buchbinder noted in a 2021 article highlighting these types of investment opportunities.


Semiconductors, chemicals and oil are also interesting, he says, given their recent difficulties and growing signs of a turnaround.


“This has been Godot’s recession; we’ve all been waiting for it,” Buchbinder says. “But because of that fear, many companies started pulling back in anticipation of a downturn. The Fed started raising rates. And now there are fewer imbalances in the economy. So there are fewer things that can go wrong from here.”


Travel & leisure activities rise while commercial real estate sinks

The image shows a line graph depicting the cumulative total return year-to-date for publicly traded hotels, resorts and cruise lines (represented by a navy-blue line) versus office REITs (represented by a light blue line) for the periods ranging from December 30, 2022, to June 30, 2023. The vertical axis lists the total returns to date in percentages. Both sectors rose through the start of 2023. REITs began a sharp decline at the end of February while hotels, resorts and cruise lines saw a slight decline then continued to steadily rise. The graph shows hotels, resorts and cruise lines rising to 40.7% as of July 25, 2023, while REITs have fallen to negative 8.2% for the same period.

Sources: Capital Group, Standard & Poor's, Refinitiv Datastream. A real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate. As of July 25, 2023. Past results are not predictive of results in future periods.

“In this environment,” he added, “I am increasingly focused on industries that are discounting some additional economic weakness that may never show up.”



Jared Franz is an economist with 18 years of investment industry experience (as of 12/31/2023). He holds a PhD in economics from the University of Illinois at Chicago, a bachelor’s degree in mathematics from Northwestern University and attended the U.S. Naval Academy.

Chris Buchbinder is an equity portfolio manager with 28 years of investment industry experience (as of 12/31/2023). He holds bachelor's degrees in economics and international relations from Brown. 

Pramod Atluri is a fixed income portfolio manager with 20 years of investment industry experience (as of 12/31/2023). He holds an MBA from Harvard and a bachelor’s degree from the University of Chicago. He is a CFA charterholder.


The Manufacturing Purchasing Managers' Index (PMI) measures the activity level of purchasing managers in the manufacturing sector.
 

The S&P CoreLogic Case-Shiller 20-City Composite Home Price Index and S&P 1500 Indexes are products of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2023 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part is prohibited without written permission of S&P Dow Jones Indices LLC.

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