A potential US recession in the second half of 2023 could actually be “good news” for markets, according to Michael Yoshikami, founder and CEO of Destination Wealth Management. Yoshikami believes that if the economy avoids a slowdown and continues on its current path, there could be problems in the market later in the year.
The US consumer price inflation eased to 4.9% year on year in April, the lowest annual pace since April 2021. This decline in inflation has been seen as a positive sign that the Federal Reserve’s efforts to curb inflation are starting to have an impact. However, both the headline consumer price index and the core CPI (which excludes volatile food and energy prices) remain well above the Fed’s 2% target. The core CPI rose by 5.5% annually in April, reflecting a resilient economy and a tight labor market.
Despite the Fed’s commitment to fighting inflation, minutes from the last Federal Open Market Committee meeting revealed a division among officials regarding interest rates. The Fed increased rates by another 25 basis points, but Chairman Jerome Powell hinted at a potential pause in the hiking cycle at the June meeting. Some members still believe there is a need for additional rate hikes, while others anticipate a slowdown in growth that could eliminate the need for further tightening. The market is currently pricing in cuts by the end of the year, indicating a 35% probability of the target rate ending the year in the 4.75%-5% range.
Yoshikami suggests that the only way interest rate cuts would occur is if there is a prolonged recession, which he believes is unlikely without further policy tightening. He argues that a slower economic growth or even a shallow recession might be considered good news for the market because it could lead to interest rate cuts. However, if the economy continues on its current path, with no recession in sight, there could be problems in the market in the second half of the year.
Yoshikami also warns investors to be skeptical of valuations, particularly in certain sectors like tech and artificial intelligence. He advises investors to carefully assess whether the current stock prices align with future earnings projections, as overly optimistic valuations could lead to potential losses.
Given the uncertain path of monetary policy and the US economy, Yoshikami suggests that policymakers may try to influence market expectations through speeches and public declarations rather than immediate rate cuts. The process of cutting rates would be considered a drastic move, despite market pricing indicating a possibility of rate cuts in the future.
In conclusion, while a US recession may bring relief to markets in terms of potential interest rate cuts, the absence of a slowdown could pose challenges for investors. Careful evaluation of valuations and a watchful eye on the economic landscape will be crucial for navigating the market in the coming months.