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13 July 2019
The Federal Reserve is signaling that it's ready to cut interest rates, in an effort to protect the U.S. economy from a global slowdown in economic growth.
Lower interest rates are a classic tool the Fed uses to prop up the economy when it's struggling. But it may be too late to prevent a recession.
This may seem surprising, since the stock market has been surging and continuing to set new records. It's gotten an extra boost from the anticipated Fed rate cuts. But the bond market, which is far larger than the stock market, tells a different story.
Investors have been piling into long-maturity bonds as a safe haven from what they see as weak economic performance ahead. The New York Fed's recession prediction model, which is based on the behavior of the bond market, is spiking. Its June reading jumped to 32.88, up from 28 in May. Since 1960, every time that index has breached 30, a recession has followed. According to the gauge, there's a strong chance of a recession within the next 12 months.
The reason the Fed's coming rate cuts won't help is that they're late to the party. In making its policy decisions, the Fed uses backward-looking data—such as last month's employment growth. While it's studying that data, consumers may be starting to cut back on spending, employers may be starting to hire fewer people, and so on.
What does a projected recession mean for stocks? If the forecast is true, investors will realize before long that stocks are overpriced. It'll become particularly clear if companies start missing their projected earnings for this quarter. Investors will start selling, and a correction could ensue—perhaps chopping 10% or more off the S&P 500. The stock market is a leading indicator of recessions, meaning that it will react to an economic downturn before it occurs, usually six months out or so.
As always, it's important to keep things in perspective and not overreact. Experts say that the next recession would be mild compared with the preceding ones in 2001 and 2008. The pain of those recessions was amplified by runaway mortgage lending and dot-com mania. We haven't seen those kinds of excesses in this expansion cycle.
It's always important to remember that there is always a way to make money, whether markets are headed up or down. Now could be the time to sell some of your winners and buy quality stocks that haven't performed as well but could benefit from any turbulence ahead. Doing that could help protect you from a market selloff, but also position you to do well once stocks rebound.
Finally, a correction would probably be a pause that refreshes in what has been a long-term bull market in U.S. stocks. Now is the time to make thoughtful, confident decisions. Don't hesitate to contact us if you'd like to do a review of your investments.