When will the recession hit the stock market?​

Most economists agree that a recession is inevitable in stock investing. Since it is not a question of if it will happen or not, but when. And on that question, the cycle of hope, created by Piper Sandler chief investment strategist Michael Kantrowitz, may offer some insight. It shows how high interest rates impact four key parts of the economy: housing, orders, profits and employment. So let's take a look at the cycle and see what it tells us now...

Real estate market: it is the first to stop️​

The first sector to react to higher interest rates is the real estate market, and it tends to react in a big way. After all, real estate is the largest asset class in the world and is directly linked to other important sectors of the economy: consumer retailers, for example, and banks.

Here, higher interest rates translate into higher mortgage rates, which drives up the cost of buying a home and reduces demand. And when mortgage rates rise quite, quite quickly, as they have recently (the rate on a 30-year fixed mortgage loan in the US just surpassed 6%, up from 2,5% a few months ago) , the impact is almost immediate. Potential buyers are forced to leave the market; while sellers find that they have to wait longer to find a buyer and may have to compromise on price.

What do the data tell us?​

The NAHB Housing Market Index, which takes the pulse of the single-family housing market by surveying people about things like housing affordability, how many potential buyers toured new homes, and expected sales, peaked in 2021 and recently fell by a sixth. month in a row.

New homes and construction permits, an indicator of new home construction, have also slowed. And since these indicators show that the peak occurred a few months ago, we are probably already past stage 1.

Orders: new orders from companies and consumers decrease 

When companies expect consumers to reduce their spending soon, they adjust their production as soon as they can. And right now, there are many reasons why consumers are about to tighten their belts: Higher housing costs and higher prices for food, gas and utilities are tightening household budgets and making they are more likely to reduce their expenses.

What do the data tell us? ​

El ISM Manufacturing New Orders, which surveys more than 400 companies on new orders, inventories, backorders and production plans, has been falling steadily since last year. And with the confidence of the consumers y the companies falling off a cliff, we are unlikely to see rapid change. That said, the new orders for consumer goods have remained strong and manufacturing sector sales They have only experienced a small drop.

This suggests that we may be close to the middle of that second stage. If that's true, we likely have less than a year before the overall economy begins to slow (T = 0 in the chart above).

Benefits: Eventually, companies are affected

If corporate profits appear to have remained remarkably resilient, that is because, as the framework shows, the impact of higher rates on profits is not immediate. It takes hold only after consumers tighten the purse strings.

And in the short term, companies can often maintain their profits by cutting costs, shifting some other costs to their consumers, or delaying spending. But eventually, a slowdown in consumer spending and an increase in production and financing expenses begin to bite, and companies' profits decline. At this point, companies will have to significantly tighten their belts, laying off workers and abandoning expansion plans. This has huge repercussions on the rest of the economy and is why a reduction in profits tends to be quickly followed by a slowdown in the rest of the economy.

What do the data tell us? ​

Los capital goods (goods used to produce other goods), the Industrial production and the average weekly overtime hours (AWH) of production and non-supervisory employees in the manufacturing sector continue to grow, although at a slower pace. This suggests that we have not yet reached the stage where profits are reduced, but that we are getting closer. And when we get there, it will most likely be less than a year before the rest of the economy follows the slowdown.

Employment: the final brake

Employment is the last to react to higher interest rates and begins to slow only after the broader economy. Only when companies are aggressively downsizing, when consumers have cut back on spending, and when housing prices have fallen from their highs for a few months does unemployment rise, wages and profits slow, and inflation declines.

What do the data tell us?​

The payroll and personal income They are solid, and the Underlying CPI is high. And while many point to those factors as evidence of economic resilience, that overlooks current economic conditions. Put another way, higher interest rates are already weakening the economy, but it doesn't yet show up in those lagging economic indicators.

So when will the recession hit stock investing?

The HOPE cycle roadmap and data suggest that we are well into the slowdown, in the “Orders” phase. And that tends to precede a broader slowdown in the economy by six to 12 months. It doesn't necessarily predict that we'll enter a recession (after all, it's a roadmap, not an exact recipe), but it certainly shows that slowing growth could happen sooner than some economists expect.

So we need to watch for signs of a slowdown in corporate profits for the second half of this year, as it may indicate that the framework is developing and that the economy is likely to enter a recession at some point next anus.

In terms of what we need to do with our portfolio, we think a defensive stance is still warranted, at least until the slowdown in corporate earnings becomes clearer in the data. In the meantime, we have to make sure we have high-quality companies in defensive industries.