Will We See Recession in 2024?

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The U.S. economy is holding steady in the latter half of 2024, but despite a cooling in inflation, progress has been uneven. The labor market remains stable, yet the Federal Reserve has been cautious about transitioning to interest rate cuts.

Many economists, including members of the Federal Open Market Committee (FOMC), predict a soft landing for the U.S. economy in 2024, with slower GDP growth but no recession. However, global markets experienced turbulence in early August after a weaker-than-expected U.S. jobs report, which saw the unemployment rate rise to 4.3%. This sparked concerns of a potential economic downturn, leading investors to sell off stocks and risky assets in favor of government bonds. By late August 5, the three major U.S. stock indexes—the New York Stock Exchange, Nasdaq, and Dow Jones Industrial Average—had each dropped by about 2.5%.

A single misstep in Federal Reserve policy could significantly slow the economy, potentially triggering a recession. As a result, the next few months are critical for the central bank. Investors are anticipating a rate cut by the Fed in September, possibly by half a percentage point, with the potential for an emergency rate cut before then.

Recessions are a normal part of economic cycles, occurring regularly over the past century. However, investors can navigate challenging times by understanding key risk factors and strategically positioning their portfolios in preparation for a possible recession in 2024 or 2025.

2024 Recession Risk Factors

Several factors can contribute to or trigger a recession, but two major risks stand out for 2024:

1. Inflation

Inflation remains the primary economic risk in 2024. After reaching a 40-year high of 9.1% in June 2022, year-over-year consumer price index inflation had dropped to 3% by June 2024. While the Federal Reserve has made significant progress, the latest core personal consumption expenditures (PCE) price index in late July indicates that it’s too early to declare victory over inflation. Core PCE, the Fed’s preferred measure excluding volatile food and energy prices, was up 2.6% year-over-year in June, still above the Fed's 2% target.

2. High Interest Rates

Elevated interest rates are another significant risk in 2024. The Federal Reserve’s aggressive rate hikes, which have brought the fed funds target rate range to 5.25% to 5.5%, have helped curb inflation but also increased borrowing costs. This discourages companies from taking on debt to invest in growth and reduces consumer spending, easing demand pressures. The bond market currently prices in a 95% chance that rates will decrease by at least a full percentage point by year-end, potentially stimulating the economy. However, the FOMC has only guided for one rate cut in 2024, and that projection was made before the July jobs report.

The final phase of the inflation battle may be the toughest due to so-called sticky inflation, which affects goods and services with prices that are slow to respond to monetary policy changes, such as children’s clothing, auto insurance, and medical products. Sticky inflation could prevent the Fed from achieving its inflation target as quickly as hoped, potentially delaying rate cuts.

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Will There Be a Recession in 2024?

So far, inflation and rising interest rates have not significantly harmed the U.S. economy, but there are warning signs of a slowdown in the second half of the year. The U.S. economy added only 114,000 jobs in July, and the unemployment rate edged up to 4.3%.

Investors should closely monitor labor market trends and other economic indicators in the coming months, as tight monetary policy often impacts growth with a lag. While U.S. GDP growth slowed from 3.4% in Q4 2023 to 1.4% in Q1 2024, it rebounded to 2.8% in Q2. The Federal Reserve projects an annual growth rate of 2.1% in 2024, but maintaining this growth may be challenging without interest rate cuts.

The inverted U.S. Treasury yield curve since mid-2022, a historically reliable recession predictor, is one of several concerning signs. U.S. credit card debt has exceeded $1.1 trillion, with delinquency rates at their highest in over a decade. Auto loan delinquencies are also rising, indicating potential weakening of consumer strength. While a 4.3% unemployment rate isn’t historically high, it is the highest since October 2021.

Nick Colas, co-founder of DataTrek Research, points out that widening corporate bond spreads are another indicator of potential economic slowdown. "Corporate bonds are whispering 'economic slowdown' even as the S&P 500 remains near record levels," says Colas.

The S&P 500’s strong performance in the first half of 2024 was driven by resilient earnings growth and anticipation of significant Fed rate cuts. However, the New York Fed’s recession probability model still suggests a 55.8% chance of a U.S. recession within the next 12 months.

Jeff Buchbinder, chief equity strategist for LPL Financial, emphasizes that earnings growth will be key for the S&P 500 to maintain momentum in the second half of the year. According to Buchbinder, "LPL Research believes stocks have gotten a bit ahead of themselves, but a solid earnings season could support the market in the near term."

An August 2 FactSet report showed that 78% of S&P 500 firms that had reported Q2 earnings exceeded analysts’ estimates. However, the magnitude of these earnings surprises was below average, and some key companies, like Amazon.com Inc. (AMZN), saw their stocks slide despite beating expectations due to weak guidance and disappointing results in certain segments.

Investment Strategies During a Recession

Investors can adopt several strategies to manage risk and capitalize on opportunities if the U.S. enters a recession in 2024.

First, reducing exposure to volatile stocks and increasing cash holdings can minimize market risk and provide flexibility to take advantage of buying opportunities. Cash may not be exciting, but it offers safety, and current yields on one-year certificates of deposit can exceed 5.3%.

Certain sectors, like utilities, health care, and consumer staples, tend to outperform during recessions due to their defensive nature. Additionally, stocks like Walmart Inc. (WMT), Abbott Laboratories (ABT), and Synopsys Inc. (SNPS) have historically outperformed the S&P 500 during previous U.S. recessions.

Long-term investors might also consider staying the course, ignoring short-term market volatility. James Demmert, chief investment officer at Main Street Research, advises not to be spooked by a potential economic slowdown. He believes the AI-driven bull market could last for years, potentially pushing the S&P 500 above 6,000 by the end of 2024.

For now, investors should focus on earnings growth, FOMC policy updates, and stock market valuations to navigate the uncertain economic landscape of the second half of 2024.

Alright! This should get you ready for the markets this week!

May Your Profits Grow!

Pete
Invest with Pete

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The information provided in this newsletter is for informational purposes only and does not constitute financial advice. Readers should seek their own independent financial advice before making any investment decisions. Please note that while Pete is a portfolio manager, the opinions expressed in this newsletter are his own and do not represent the views of any organization. Always perform your own research and due diligence before investing.