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Recession in 2024? Here's What It Means for Stocks
Every weekend I listen to my favorite podcast called the "All-In" podcast. Hosted by four successful venture capitalists, the podcast dives into everything from current events to politics to the stock market and does so in a very balanced and unbiased manner (in my view).
Last week, the moderator, Jason Calacanis, asked his fellow hosts whether they thought a U.S. recession was on the horizon. The thoughtful discussion inspired me to write this piece and reminded me that one of the most misunderstood economic concepts on Wall Street is the term "recession."
The hard truth is that most amateur investors do not understand what a recession is, and the ones who do rarely understand its impact or correlation to stock prices. In today's commentary I will define a recession, illustrate how the private sector may have already suffered one, and explain why a recession's impact on Wall Street is far less than most investors think.
What's a Recession?
Economists and inexperienced investors often use the term "recession" as an umbrella to describe a floundering economy where growth is slowing and many people are out of work. Though these traits are often inherent in typical recessions, a common error is not using the most popular, accepted, and precise definition of a recession: two consecutive quarters of declining Gross Domestic Product (GDP).
Why does having a precise definition matter so much? If investors use an imprecise definition of something, they cannot accurately study the historical data and past recessions' impact. Another practical example is that there is no magic to Wall Street's widely accepted definition of a correction (a 10% drawdown off highs). Nevertheless, by defining and pinpointing these terms, investors can better organize their thoughts, data, and game plan.
Are We Already in a Recession? Some Stealth Signs
Signs the Consumer Is Already Weak
When asked about the economy and recession potential, the All-In hosts acknowledged that the consumer is showing some signs of weakness, as evidenced by hospitality company Airbnb's disastrous revenue numbers that pounded shares by more than 10% in a single session. I have also made the observation recently by highlighting AI lending platform Upstart's monstrous quarter. Upstart's strong earnings are another hint the consumer is in trouble.
Government Spending to GDP
Though I underscored the importance of using the precise definition of a recession, investors must understand what accounts for GDP and, thus, what has led to the U.S. economy avoiding a recession thus far. All-In co-host David Sacks made the astute observation that government spending has gone "hog wild" and that "if you were to remove the impact of government spending, it's pretty clear that the private sector is in a recession."
In other words, rampant spending on both sides of the aisle leads to an economy artificially avoids our recession definition. With the government spending to GDP ratio at more than 20%, the U.S. economy is more reliant on government spending for economic growth than ever.
What does this mean for investors?
If you discount government spending, we likely already suffered a recession or are in one now.
Given that the country's political representation is relatively split in Washington and the fact that politicians on both sides of the aisle show little real desire to cut government spending, an actual recession can still potentially be avoided.
Fed Will Cut Interest Rates
Poor Jobs Numbers Hint at Potential Rate Cut
The biggest piece of the recession puzzle is Jerome Powell and the powerful U.S. Federal Reserve central bank. Fed Chair Jerome Powell and the Federal Reserve have used their monetary tools to quell inflation by hiking interest rates 11 times since early 2022. However, the odds of an interest rate cut by the end of 2024 have skyrocketed after the unemployment rate jumped from 4.1% to 4.3% month-over-month and from 3.5% a year ago.
Cuts Will Spur Growth in Housing, Small Caps
If the Federal Reserve cuts interest rates as expected, the result will be higher growth in some weak market areas. The housing market has been at a standstill for months as supply remains constrained and new buyers shy away from higher mortgage rates.
However, a drop in rates should spur growth and demand in the real estate sector and for homebuilders like Lennar. Meanwhile, small caps and the Russell 2000have suffered as higher rates have contained them. Small caps are particularly beholden to interest rates because they typically have higher debt levels and adjustable borrowing rates, unlike their large-cap peers.
The Tech Sector Is Still Strong
Beyond the massive government spending, the artificial intelligence (AI) buildout and the tech sector have buoyed GDP growth while other market areas like small caps have floundered. Though the AI trade is no longer a secret, and the initial sugar high may have worn off, Zacks Consensus Estimates suggest that growth will continue into 2025 as margins expand in technology stocks like Arm Holdings.
Pundits and Analysts Are Often Wrong
Many Wall Street analysts predict a recession to occur in the coming quarters. However, recent history teaches us that predicting a recession is an extremely challenging endeavor, even for the most brilliant minds. For example, billionaire Stanley Druckenmiller has incorrectly predicted a recession several times over the past few years. Meanwhile, Tesla CEO Elon Musk, who probably has a better read on the economy than anyone due to his widespread business interests, has been predicting a recession since late 2022.
Economic Recession Does Not Necessarily Mean a Bear Market
An extensive research report from Russell Investments sheds light on the correlation (or lack thereof) between recessions and stock market performance. The report states:
"Looking at the 31 recessions between 1869 and 2022 as we do in our full report, the correlation between U.S. stock market returns and GDP changes over the 31 recessions is 0.30. This positive correlation is mostly driven by the 2020 recession, where GDP dropped 17.8% on an annualized basis and the market lost 63.4%. Excluding this period, the correlation is near zero."
Stocks Discount the Future
Another reason obsessing over a recession is futile is that, on average, stocks tend to peter out a full five months before a recession hits. Though this is not always the case, recessions offer little predictive power over stock prices (unless in hindsight), and recessions themselves are very difficult to predict.
Bottom Line
Wall Street may have already suffered a stealth recession masked by excessive government spending in 2022. Rate cuts and a strong tech sector will likely help the U.S. economy avoid a real recession. Nevertheless, stocks can still, and often do rise in either recessionary outcome.
Why Haven't You Looked at Zacks' Top Stocks?
Since 2000, our top stock-picking strategies have blown away the S&P's +7.0 average gain per year. Amazingly, they soared with average gains of +44.9%, +48.4% and +55.2% per year.
Today you can access their live picks without cost or obligation.
Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Zacks Investment Research does not engage in investment banking, market making or asset management activities of any securities. These returns are from hypothetical portfolios consisting of stocks with Zacks Rank = 1 that were rebalanced monthly with zero transaction costs. These are not the returns of actual portfolios of stocks. The S&P 500 is an unmanaged index. Visit https://www.zacks.com/performancefor information about the performance numbers displayed in this press release.
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Zacks Investment Ideas feature highlights: Airbnb, Upstart, Lennar, Arm Holdings and Tesla
For Immediate Release
Chicago, IL – August 13, 2024 – Today, Zacks Investment Ideas feature highlights Airbnb (ABNB - Free Report) , Upstart (UPST - Free Report) , Lennar (LEN - Free Report) , Arm Holdings (ARM - Free Report) and Tesla (TSLA - Free Report) .
Recession in 2024? Here's What It Means for Stocks
Every weekend I listen to my favorite podcast called the "All-In" podcast. Hosted by four successful venture capitalists, the podcast dives into everything from current events to politics to the stock market and does so in a very balanced and unbiased manner (in my view).
Last week, the moderator, Jason Calacanis, asked his fellow hosts whether they thought a U.S. recession was on the horizon. The thoughtful discussion inspired me to write this piece and reminded me that one of the most misunderstood economic concepts on Wall Street is the term "recession."
The hard truth is that most amateur investors do not understand what a recession is, and the ones who do rarely understand its impact or correlation to stock prices. In today's commentary I will define a recession, illustrate how the private sector may have already suffered one, and explain why a recession's impact on Wall Street is far less than most investors think.
What's a Recession?
Economists and inexperienced investors often use the term "recession" as an umbrella to describe a floundering economy where growth is slowing and many people are out of work. Though these traits are often inherent in typical recessions, a common error is not using the most popular, accepted, and precise definition of a recession: two consecutive quarters of declining Gross Domestic Product (GDP).
Why does having a precise definition matter so much? If investors use an imprecise definition of something, they cannot accurately study the historical data and past recessions' impact. Another practical example is that there is no magic to Wall Street's widely accepted definition of a correction (a 10% drawdown off highs). Nevertheless, by defining and pinpointing these terms, investors can better organize their thoughts, data, and game plan.
Are We Already in a Recession? Some Stealth Signs
Signs the Consumer Is Already Weak
When asked about the economy and recession potential, the All-In hosts acknowledged that the consumer is showing some signs of weakness, as evidenced by hospitality company Airbnb's disastrous revenue numbers that pounded shares by more than 10% in a single session. I have also made the observation recently by highlighting AI lending platform Upstart's monstrous quarter. Upstart's strong earnings are another hint the consumer is in trouble.
Government Spending to GDP
Though I underscored the importance of using the precise definition of a recession, investors must understand what accounts for GDP and, thus, what has led to the U.S. economy avoiding a recession thus far. All-In co-host David Sacks made the astute observation that government spending has gone "hog wild" and that "if you were to remove the impact of government spending, it's pretty clear that the private sector is in a recession."
In other words, rampant spending on both sides of the aisle leads to an economy artificially avoids our recession definition. With the government spending to GDP ratio at more than 20%, the U.S. economy is more reliant on government spending for economic growth than ever.
What does this mean for investors?
Fed Will Cut Interest Rates
Poor Jobs Numbers Hint at Potential Rate Cut
The biggest piece of the recession puzzle is Jerome Powell and the powerful U.S. Federal Reserve central bank. Fed Chair Jerome Powell and the Federal Reserve have used their monetary tools to quell inflation by hiking interest rates 11 times since early 2022. However, the odds of an interest rate cut by the end of 2024 have skyrocketed after the unemployment rate jumped from 4.1% to 4.3% month-over-month and from 3.5% a year ago.
Cuts Will Spur Growth in Housing, Small Caps
If the Federal Reserve cuts interest rates as expected, the result will be higher growth in some weak market areas. The housing market has been at a standstill for months as supply remains constrained and new buyers shy away from higher mortgage rates.
However, a drop in rates should spur growth and demand in the real estate sector and for homebuilders like Lennar. Meanwhile, small caps and the Russell 2000have suffered as higher rates have contained them. Small caps are particularly beholden to interest rates because they typically have higher debt levels and adjustable borrowing rates, unlike their large-cap peers.
The Tech Sector Is Still Strong
Beyond the massive government spending, the artificial intelligence (AI) buildout and the tech sector have buoyed GDP growth while other market areas like small caps have floundered. Though the AI trade is no longer a secret, and the initial sugar high may have worn off, Zacks Consensus Estimates suggest that growth will continue into 2025 as margins expand in technology stocks like Arm Holdings.
Pundits and Analysts Are Often Wrong
Many Wall Street analysts predict a recession to occur in the coming quarters. However, recent history teaches us that predicting a recession is an extremely challenging endeavor, even for the most brilliant minds. For example, billionaire Stanley Druckenmiller has incorrectly predicted a recession several times over the past few years. Meanwhile, Tesla CEO Elon Musk, who probably has a better read on the economy than anyone due to his widespread business interests, has been predicting a recession since late 2022.
Economic Recession Does Not Necessarily Mean a Bear Market
An extensive research report from Russell Investments sheds light on the correlation (or lack thereof) between recessions and stock market performance. The report states:
"Looking at the 31 recessions between 1869 and 2022 as we do in our full report, the correlation between U.S. stock market returns and GDP changes over the 31 recessions is 0.30. This positive correlation is mostly driven by the 2020 recession, where GDP dropped 17.8% on an annualized basis and the market lost 63.4%. Excluding this period, the correlation is near zero."
Stocks Discount the Future
Another reason obsessing over a recession is futile is that, on average, stocks tend to peter out a full five months before a recession hits. Though this is not always the case, recessions offer little predictive power over stock prices (unless in hindsight), and recessions themselves are very difficult to predict.
Bottom Line
Wall Street may have already suffered a stealth recession masked by excessive government spending in 2022. Rate cuts and a strong tech sector will likely help the U.S. economy avoid a real recession. Nevertheless, stocks can still, and often do rise in either recessionary outcome.
Why Haven't You Looked at Zacks' Top Stocks?
Since 2000, our top stock-picking strategies have blown away the S&P's +7.0 average gain per year. Amazingly, they soared with average gains of +44.9%, +48.4% and +55.2% per year.
Today you can access their live picks without cost or obligation.
See Stocks Free >>
Media Contact
Zacks Investment Research
800-767-3771 ext. 9339
support@zacks.com
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Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Zacks Investment Research does not engage in investment banking, market making or asset management activities of any securities. These returns are from hypothetical portfolios consisting of stocks with Zacks Rank = 1 that were rebalanced monthly with zero transaction costs. These are not the returns of actual portfolios of stocks. The S&P 500 is an unmanaged index. Visit https://www.zacks.com/performancefor information about the performance numbers displayed in this press release.