Hard Landing or Soft?

It’s been a long haul for equity investors since the Fed started increasing interest rates in March 2022. By mid-October, the S&P 500 had declined by about 20%. Add in a regional banking scare starting in March 2023, and the result has been heightened volatility.

Why has the market done as well as it has? Two related factors have been crucially important: the sturdiness of the labor markets and the strength of consumer spending. While both have softened a bit recently, it has come as we approach peak yields and peak Fed hawkishness.

True, inflation and higher interest rates mean recession looks like the most likely scenario later this year. The consumer has depleted much of their savings over the past year amid historically high prices. Credit is tighter due to higher interest rates and the condition of the regional banking sector. This means consumers are paying more for credit card interest and other loans, reducing available funds for discretionary spending. Layoffs especially in the tech sector, are starting to add up, and job openings have declined.

While these factors are important, none of them have gone through a precipitous decline. Much of the economy’s weakness has been in the manufacturing sector, which accounts for only about 12% of the US economy. Services represent a much bigger portion.

The Seven’s Report recently made the case for the so-called “soft-landing.” They analyzed the three biggest factors, in their view, for whether the economy will drop off suddenly or ease through the slowdown. Looking at the ISM Manufacturing report, and job additions from the Labor Department, only one (manufacturing) is pointing to a hard landing. In addition, they reviewed retail sales, business spending, and jobless clames. All of these are slowing but are not in a sharp negative trend, which would be indicative of a hard landing.

If there is a soft landing, that means we will avoid a recession, or it will be mild at worst. This does not point to the Fed decreasing interest rates aggressively as some analysts (and the markets) currently think. But it does signal the end of the higher interest rate cycle and that, as our readers know, is what we’ve been looking for.

We expect more volatility over the next few months.Generally, summers are usually rockier for the investment markets often followed by a year-end rally. Historically, markets have climbed a “wall of worry.” They’re always reasons to be concerned but markets seem to always push through those issues and eventually climb to new higher, highs.