Market Stress, Cardi B, and Economic Indicators

One of my middle school English teachers had a sign next to her desk that read “The floggings will continue until morale improves.” Even as a middle schooler, the irony of that phrase was not lost on me. How could perpetual floggings improve morale?

That quote has come to mind on several occasions over the last few months. Investors continue to wonder when the market’s proverbial floggings will come to an end.

Over the last few weeks, I am often discussing the three different types of economic indicators with clients: leading, coincident, and lagging.

Lagging indicators are data points that tell us what already happened. CPI (Consumer Price index) is an example of a lagging indicator frequently discussed during the last few months because of inflation. CPI tells us if prices accelerated or decelerated in the past. It does not tell us what is happening in the current moment or what will happen in the future.

Coincident indicators tell us what is happening right now. GDP (Gross Domestic Product) is often thought of as a coincident indicator. It tells us the current output of the economy.

Leading indicators are like an economic crystal ball. These indicators tell us what is on the horizon for the economy. Historically, the stock market is one of the best leading indicators, and this is something that confuses many market participants. The stock market doesn’t tell us what already happened or what is happening. The stock market tells us what is going to happen to the economy.

With that in mind, what does a 20% market decline tell us about the future of the US economy? We should expect the economy to slow in the second half of 2022. With accelerating prices putting pressure on the consumer, this likely does not surprise you to read this.

Since the stock market is a leading indicator of the economy, we must forecast where we believe the economy is going in the second half of the year and beyond to determine the near-term direction of the market. In my opinion, there are three possible scenarios.

Scenario 1

Before I describe this scenario, I believe this possibility is least likely. I would assign an extremely low probability to this scenario, but it would also be irresponsible to ignore its possibility.

There is always a chance there is a crisis lurking in the economy. It is difficult to see what could cause a crisis right now. Corporations may be better prepared to handle financial stress than any other time in history because of the strong economy in recent years. The same can be said for consumers too.

Unfortunately for investors that believe this outcome is likely, a 20% decline in the S&P 500 has not priced in this risk based on previous crises. Further downside could be possible.

I want to reiterate this is the outcome I believe is least likely. The following two scenarios are where I would assign the highest probabilities.

Scenario 2

The economy moves into a recession in the second half of the year. Higher prices on almost all goods are beginning to stress the consumer. Consumer spending is slowing, and businesses – specifically retailers – recently shared concerns about growing inventories. Notable individuals in the financial services industry like Jamie Dimon recently shared their concerns about a coming recession.

The question for investors is whether the market already priced in this risk, and in my opinion, the answer is yes. The S&P 500 declining 20% is consistent with previous recessions. This does not mean the market couldn’t fall further – it has in previous cycles while in others it has gone down less than 20%. Either way, a 20% decline is discounting a significant amount of future risks.

Since the stock market is a leading indicator, it’s important to remember the market typically begins to recover ahead of the economy. Even if the economy enters a recession in the second half of this year, I believe the market begins to recover some of the first half losses as it begins to forecast the economy’s eventual recovery. The stock market is a leading indicator going into AND moving out of recessions.

Scenario 3

This is the scenario that I believe is most likely. I share a few of the reasons below, but I will spare you all the reasons because there are many. Call me or email me if you want to discuss further!

In this scenario, the economy slows down but does not slow enough to be considered a recession. This is the “soft landing” the Federal Reserve hopes to orchestrate with interest rate policy. The media treats a soft landing as mythical and impossible, but it’s important to note the Federal Reserve was successful in orchestrating this outcome a few years ago in 2018. It’s not as elusive as many pundits suggest.

Should this scenario happen, a 20% decline in the market is likely too extreme and could lead to a sharp reversal.

We would likely need the pace of interest rate increases to slow for this to be our reality. This may seem unlikely – especially after the recent inflation data – but I would urge you to remember CPI is not a leading indicator. It is a lagging indicator.

Incoming data is beginning to show inflation pressures are easing. For example, lumber prices are down over 60% from their highs in early March and cattle prices are down over 7% from their highs in early February. Some major retailers announced discounts are coming because of high inventory. These are just three data points of many I am seeing that show inflation may be at an apex. I also suspect this data is a surprise to most individuals given what is currently reported in the media.

If the Federal Reserve is data-dependent like they claim, the incoming economic data could be enough for them to slow the pace of rate increases in the second half of 2022. This policy reversal would be a welcome surprise for the markets and could trigger a major reversal.

There are also a few interesting anecdotes that show we may be close to an inflection point for markets. Before I share these, remember from my last note that I am not a proponent of market timing. It is almost impossible to do successfully.

There are several organizations in my industry that track investor confidence. Historically, extreme pessimism in these polls is an indicator of turning points in the market, and across the board, these polls are showing some of the most extreme pessimistic readings we have ever seen in their history.

The final anecdote I saw last week is a new indicator I’ve never seen. It involves a notable Wall Street analyst and pop music sensation Cardi B.

Richard Bernstein was the Chief Investment Officer at a major financial institution before starting his own research and investment management firm about a decade ago. He is an outstanding thought leader in my industry that I follow closely.

Cardi B is an artist that gained notoriety several years ago when one of her songs became extremely popular. Everyone is entitled to their own music tastes, but consider yourself lucky if you’ve never heard of Cardi B. If you decide to look up her work, make sure your children or grandchildren are not within earshot. Consider yourself warned!

Earlier this week, Cardi B tweeted:

“When y’all think they going to announce that we going into a recession?”

I only became aware of this when I saw Rich Bernstein respond to her with the tweet:

“IF a recession is looming it’ll be the first one ever that everyone “knew” was coming.”

I was SHOCKED to see one of Wall Street’s most well-respected analysts and money managers responding to anything Cardi B says. It makes me wonder what is on his Spotify playlist and why he is following Cardi B on Twitter.

I’m still waiting on Rich’s response to my questions, but his point shouldn’t be lost in the absurdity of how he made it. Most recessions are surprises. If we find ourselves in one later this year, it would be one of the first virtually everyone saw coming. I also hypothesize that a well-renown Wall Street analyst responding to anything from Cardi B only happens at market extremes. Time will tell if my hypothesis is correct.

It’s important to remember we shouldn’t allow difficult markets to derail our long-term investment strategy. Before we make major changes, it’s important to evaluate them in the context of your financial plan. These are the conversations I enjoy, and I’m having them often right now.

Please contact us if you have questions or concerns. Please share this with anyone that you think could benefit, and let me know if there are any friends, family, or business associates that could benefit from a conversation with our team.

Any opinions are those of the author and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance is not indicative of future results. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary.