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Investors are increasingly concerned about the US recession. However, the speed of corrections in the financial markets seems to offer a bit of peace. Some say that in 2007 there was a “tsunami” and now it will be a “hurricane”.
How changeable the US capital market has been this year, only a madman would have dared to venture to predict quotes in the middle or at the end of the week. At the close of trading on May 27, for example, they rose, so that the S&P 500 index of the most profitable American stocks managed to end the seven weeks of decline. Thus, the maximum decline of 20% was avoided, which, in an informal definition, characterizes a falling market (so-called “bear market” in financial jargon). But there are signs that American markets are preparing to enter a more worrying phase, comment the British from The Economist.
From January to early May, falling prices could be attributed to rising bond yields, as markets responded to US Federal Reserve (Fed) indications that the monetary policy interest rate could rise much and fast. The higher interest rate reduces the current value of a flow of future profits. Quotations have fallen accordingly, especially for IT companies, whose profits can be forecast for the longer term. However, in recent weeks, quotations have continued to decline, as bond yields have also declined. This combination reflects fears of a recession.
The mix between tightening monetary policy measures, slowing gross domestic product (GDP) growth and rising production costs leads to the ominous feeling that we are at the end of an economic cycle. The growth is no more than two years old. However, investors already fear that their profits are threatened.
Let’s recap quickly – the global economy has been hit by several big shocks. China’s gross domestic product will contract sharply in the current quarter due to new lockdowns, and European consumers have lost their purchasing power amid rising energy prices. The U.S. economy seems to be holding up, but economic areas that are sensitive to rising monetary policy interest rates are suffering, even though the Fed has barely made the first adjustment – May 24 figures show new home sales fell nearly 17 percent between March and April.
Markets are watching for any signs of companies reporting, especially when they indicate a decline in demand. When Snap, the company behind Snapchat, announced in late May that sales would be lower than estimated in April, its share price fell 43 percent. The shares of Walmart and Target also fell when the two retailers reported unsold stocks after an erroneous sizing of demand.
Weaker growth is a textbook item that puts pressure on profit. One effect of the most stable cost base for corporations is that when sales increase or decrease, profits fluctuate in the same way, up and down, respectively, but more drastically. It is the effect that explains the considerable increase in profits last year, but which, as GDP falls, will also adjust downwards.
Another element of the erosion of profitability is given by higher costs. Several blockages have put pressure on the price of key commodities, such as energy. Public debt costs increase with increasing interest rates. But the main fear is about wages. The labor market in America is very balanced in terms of supply and demand, so wage increases have become generous. Now, companies are caught between hammer and anvil – if they transfer higher wage costs into higher prices for products or services, then inflation will be fueled and the Fed will be forced to raise the interest rate even more aggressively. But if they decide to absorb the salary increases, then they will significantly erode their profitability.
The risk of a hard landing is still underestimated, according to Bloomberg. According to Federal Reserve officials, tightening monetary policy can slow the economy and eliminate the imbalance between supply and demand in the labor market without causing an economic downturn. And from this point on is history – every time the unemployment rate rose by half a percentage point or more, the effects were a serious recession and an even deeper deepening of unemployment. But given that the labor market (the demand-to-supply ratio) is now more balanced than ever, the pressure for the unemployment rate to rise is higher, which raises the risks of a hard landing, not less.
The question is whether there is any improvement leverage for investors. Some are talking about a market return – their theory is that if many have already sold their shares, then there will be fewer potential sellers pushing for lower prices in the future. But a return based only on such a balance of positions (sell-buy) will not influence in any way the unfortunate macroeconomic context for assets.
If one really wants to find some consolation in the current situation, then one has to look at the fact that the financial markets have taken over much of the effort that the Federal Reserve should have made. Since the beginning of the year, bond yields have risen sharply, mortgage rates have risen, spreads on private bonds have risen, the dollar has strengthened and stock prices have fallen. In a counterfactual world where the financial markets would not have taken into account the two Fed increases so far, the risks of a hard landing of the global economy would be, paradoxically, higher. Inflationary pressures will increase. But as things stand now, interest rates will most likely not rise as they did in the past. Against the background of the bad days of the capital market, the consolation is not great, but anything helps, conclude those from The Economist.
This article appeared in issue 142 of . magazine.