On July 28, the answer to the recession debate will finally be settled with the release of Q2’s preliminary gross domestic product (GDP) data.

During Q1, GDP contracted by 1.5%. So, another negative reading would make it official.

It’s a question that’s recently been plaguing the markets and weighing down on sentiment… maybe even acting as a self-fulfilling prophecy.

The concept of “talking yourself into a recession” is real.

It affects behavior all the way from postponing real estate purchases, to cutting back on consumer spending.

And it’s helped shape the current view on markets. A bearish outlook on markets is now the consensus view.

In addition, the Fed looks like it’ll raise interest rates by (at least) another 75-basis points a day before the GDP release.

So, the markets should be preparing to be knocked down to new lows.

Yet, the markets are showing some resiliency. They’re now up 1.4% MTD. It’s nothing to write home about, but it is stabilizing.

And it shouldn’t come as a surprise.

That’s because the Wall Street mantra – history doesn’t repeat itself, but it often rhymes – has been taken just a little too far… and used just a little too often.

It’s a saying that gives the green light to assume the future will be like the past.

For example, most analysis I’ve seen look to past recessions, periods of inflation, and Fed tightening cycles to form predictions for today’s markets.

But we’re in uncharted territory.

Never before has the economy been so intertwined on a global scale. The size of central bank balance sheets has never been so big…

We’ve never seen this combined with a global pandemic and 50-year high inflation.

We’ve also never seen recessions in which people can keep their jobs and corporations can sit on so much cash to cushion the blow.

In fact, companies will be using their cash hoard for share buybacks to the tune of $300 billion this quarter.

That’s a lot of stock buying.

And the shortage of workers is probably why the U.S. consumer is still looking strong.

Last week’s retail sales and consumer sentiment data confirmed this, with both beating expectations.

So, if we’re in a recession, we’re in a really strange one. One where consumers continue to spend, yet the investor mood is low.

For every bearish data point, there seems to be a bullish one as well.

That’s why the market’s been stabilizing at the 3750 support level I wrote about in late June.

That level is critical beyond technical reasons. The market’s been bouncing off of it despite bad news. And that’s pointing to a situation where a lot of bad news looks like it might be priced in.

We may also be in the early stages of “runaway momentum.” This is when asset prices start rising, while lagging economic data keeps coming back negative.

A perfect example is last Wednesday’s attempt to break that same level following a 9.1% CPI print that exceeded expectations.

That’s bad inflation data, but there’s plenty of counterpoints.

For example, crude oil is down 16% from its peak in June. Natural gas is down 20%. And wheat is down 37% from its recent peak

The next CPI release will probably be lower.

Although bad, these high inflation readings will self-correct through a mechanism known as “positive reflexivity,” or a positive feedback loop.

High inflation is the cure for high inflation. Essentially, when prices become too much to bear, demand drops off. So, prices are brought down to stimulate demand again.

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If the consumer can stay resilient, and stay employed… Eventually, the economy will catch up to inflation (barring policy errors from the government) as GDP evens out and the Fed will ease up on its tightening cycle.

The Fed Funds swap market is already pricing in the start of rate cuts sometime next summer.

Meaning, the economy might very well auto correct.

Contrast this with the “negative reflexivity,” or negative feedback loop from 2008 that caused the economy to fall like dominoes in a row.

The real estate crash caused banks to fail, which then caused all credit to vanish. 

This all adds up to the big risk of joining the bearish consensus right now… Just as it was a risk to join the bull herd at the end of 2021.

But what’s encouraging is that the last remaining bear point yet to be priced in – earnings estimates – is starting to get whittled away.

Because earnings estimates are overstated, it causes a valuation mirage.

That’s when the “E” in the price to earnings ratio (P/E) is artificial.

So, when we see the S&P 500 trading at a 16X multiple (back to its multi-decade average), it’s not as cheap as we think it is.

Tech earnings will be key, but the financial sector has spoken.

Recent earnings from banks and other financials like Citigroup, Goldman Sachs, United Healthcare PNC Financial, Bank of NY Mellon, US Bancorp, Progressive Corp., and State Street Bank all beat estimates…

Some by a large margin… For example, Citigroup reported earnings of $2.19 per share compared to expectations of $1.70. And Goldman Sachs reported $7.73 compared with $6.65 a share.

We’ll continue to closely monitor earnings. After all, things can change fast.

The bears could still be right… Tech earnings are a wild card.

But right now, all is pointing to the last remaining bear case slowly becoming moot… With 3750 gaining more and more importance by the day.


Eric Shamilov
Analyst, Market Minute

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