As we progress through 2023, investors have a couple of questions: when will a recession start and will the markets retest their lows? The relationship between equity markets and recessions is not always consistent.
For example, the S&P 500 fell over 14% quarter over quarter in the third quarter of 1990 as the business cycle reached a peak. And in the following two quarters during the recession, the S&P 500 rose roughly 8% and 14% - more than enough to recover losses incurred earlier in 1990.
The base case is the U.S. economy will likely hit a recession sometime late this year, with a potential effect of that negative being pushed out into the beginning of next year. Current indicators suggest the recession will come sooner rather than later. The Conference Board’s March Leading Economic Indicators (LEI) fell to levels last seen in November 2020 when the economy was reeling from a global pandemic. Markets shrugged off the decline in the March index since investors already knew the weakness in the 10 underlying components. Historically, an economic contraction has closely followed a decline in the LEI of this magnitude. A recession may be all but certain, so the more important question is if markets will hit new lows as the economy contracts. We do not know.
The head fake from last year’s two quarters of negative economic growth and the uncertainty from an aggressive Fed were primary culprits for pushing down the markets last year. Although 2023 has its fair share of risks, including a recession, markets may not retest last year’s lows. A possible scenario may bare a semblance to the relationship between the equity markets and the 1990-91 recession.
Small businesses are often considered the backbone of the economy because of the amount of economic activity generated by the sector, and it looks like a backache has emerged. Pay careful attention to surveys from the National Federation of Independent Businesses (NFIB) for leading insights in the direction of the U.S. economy. Hiring intentions among small businesses declined in March, implying that upcoming job reports will likely be lackluster. Small businesses have an incredible impact on both the national and local economy. Small businesses make up the majority of all businesses by count, while also employing over 46% of the private sector workforce. It is not a stretch to say, “as goes the small and independent business, so goes the national economy.”
We know small businesses are especially concerned about a potential credit crunch. Firms are hunkering down as few have expansionary plans in the near future. The number of firms reporting any expansion plans is the lowest since early 2009 when the economy was in the depths of the Great Financial Crisis. No doubt, tighter credit conditions impacted those decisions. The percent of small businesses reporting tighter credit is the highest since 2012, as lending institutions tighten up under the uncertainty of the macro landscape and following mid-March banking turmoil.
Businesses appeared to hunker down under the weight of tighter credit conditions and weaker economic growth. If small businesses are an accurate barometer, recession risks are rising, and the labor market will likely cool in the coming months. Although the economy is slowing, the Fed continues to fight inflation and will likely hike rates at the next meeting on May 2- 3. However, if the economy becomes more unstable, inflation continues to decelerate, and the job market loosens, the Fed may possibly pivot to rate cuts by the end of the year.
We maintain a modest overweight allocation to equities, with a slight preference for value over growth. Consistent with increasingly cautious signals from small businesses, we are not increasing the small cap allocation beyond benchmark levels. Within fixed income, we favor quality sectors (U.S. Treasuries, Agency mortgage-backed securities (MBS), and short-maturity investment grade corporates) over plus sectors (high-yield bonds and non-U.S. sectors).
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided by Bloomberg, FactSet, and LPL Financial, tracking # 1-05368284.
- US Treasuries may be considered “safe haven” investments but do carry some degree of risk including interest rate, credit, and market risk. Bonds are subject to market and interest rate risk if sold prior to maturity..
- The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.