by Franklin J. Parker, CFA
The Summary
- This week’s important data is personal consumption expenditures—the Federal Reserve’s preferred inflation gauge. This figure should also give some insight into how households are coping with higher prices. We also see some data on manufacturing and durable goods orders this week.
- The European Central Bank announced their intent to move rates above 0% by September, which would be the first time since 2014 that rates would be above 0%. ECB president Lagarde also indicated that inflation running above 2% might prompt the ECB to push rates even higher. This follows the US central bank’s indication that aggressive rate hikes should be expected this year, with a reigning in of the cash printed over the last couple of years.
- Markets have reminded investors what volatility looks like—it was easy to forget over the past decade! Of course, with the Fed pulling back its support, and with consumers and companies struggling with higher prices, there is ample worry of a recession on the horizon (or here now). All of these changing factors indicate to me that we are in a transitionary environment—this is the “hangover” from an easy-money environment. It may take a bit to work out, but, at the moment at least, the fundamentals of the economy are still generally strong. Demand is plentiful, and it is usually a lack of demand that drives economies into a recession.
The Details
With the first quarter of 2022 posting a contraction, I could not help but wonder how often we get one-off contractions without a second quarter of contraction (two quarters of GDP contraction is the technical definition of a recession). So, I went back through the record and counted.
Since 1950, there have been 16 quarters of one-off contractions (that is, without a subsequent second quarter of contraction). As it turns out, this is not particularly uncommon—about every 1 year in every 5 we should expect a one-off bad quarter. However, there is some nuance to this.
Of those 16 one-off quarterly contractions, about 10 of them are part of a string of volatile quarters (they tend to cluster). So, for example, the year 1956 looked like this:
- Q1: -0.38%
- Q2: +0.83%
- Q3: -0.09%
- Q4: +1.65%
In other words, though not technically a recession it was a volatile year for economic growth, with each quarter bouncing between contraction and expansion. 1957 looked similar, except a recession finally hit in the last quarter of 1957 pushing into the first quarter of 1958. That two year period from 1956 to 1958 was a difficult economic environment.
As the plot below demonstrates, market returns were sub-par during that period, yet most of the losses in the S&P 500 came from the recession in the last two quarters of 1957. Recall, 1956 had two negative quarters of GDP growth, yet still delivered positive total returns. It was not until late 1957—almost 18 months after the first quarter of contraction—that the S&P 500 began to dip in earnest.
The lesson here is that volatile economic growth can create volatility in equity markets, but it is recessions that deliver the bulk of the downside. If, then, this is the start of a volatile string of quarters (like the late-1950s, or even the mid 1970s), markets can still deliver positive returns. And, as usual, investors should be on the lookout for recessions as those are what cause the most damage to portfolios.
Chart of the Week
This week’s chart comes to us courtesy of the Conference Board, and it breaks down the components of GDP growth, quarter-by-quarter. What becomes clear in this chart is that, despite the recent negative posting for GDP, consumer demand remains strong (orange). Most of the drag on GDP was from trade and reduced government spending. Despite all of the headwinds, US consumers remain strong—fueling demand in the economy.
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