ROIC ACADEMY EXCLUSIVE - Are Recession Indicators REALLY Flashing Red?

Over the past few weeks I have heard multiple experts claim we are either in a recession or at the very least heading there in hyperdrive speed. This claim is based on 5 main arguments I saw in the media recently:

• Earnings Growth is Overstated: the recent stock market gains have been driven by multiple expansions rather than earnings growth. While past earnings reports have exceeded expectations, earnings estimates for the rest of the year have been revised downward, indicating potential weakness ahead.

• Consumer Spending is Unsustainable: Consumer spending, while currently strong, is not driven by real income growth but rather by a significant drawdown in personal savings. The savings rate has dropped to historically low levels, which is unsustainable and a potential warning sign for future consumer spending.

• Signs of Recession in Key Sectors: Certain sectors of the economy, such as business capital spending, the industrial sector, and the housing market, are already in recession. While these sectors are not the largest components of the economy, their downturns are concerning.

• Federal Reserve is Behind the Curve: Federal Reserve is behind the curve in responding to economic conditions. Despite the economy and inflation normalizing, the Fed has kept interest rates higher than the neutral rate, potentially exacerbating economic issues.

• Unemployment Concerns: While the unemployment rate has not shown significant job losses, it has increased by 80 basis points, which caught the attention of the Federal Reserve Chair, Jerome Powell. This uptick in unemployment, even without significant job loss, is seen as a critical indicator by the Fed, and it may signal emerging weakness in the labor market.

  These are valid arguments, and should not be ignored, however, here are the counter arguments you need to consider as well: 

• The current bull market, often referred to as the "AI bull market," began just before the release of ChatGPT in November 2022. The S&P 500 has risen by 57.5% during this period, and while this is below the average bull market gain of 114% and the median gain of 76.7%, historical trends suggest that bull markets are typically long and steady. Therefore, this bull market may have more room to run, driven by technological innovations such as AI.

• Additionally, the tech sector, which is a significant part of the S&P 500, has shown strong earnings growth due to the AI boom, with companies like NVIDIA reporting record revenues. Historical data shows that technology-driven bull markets, like the one following the release of the web browser Netscape in 1994, can last for several years.

• The unemployment rate remains low, and wage growth, while not spectacular, has kept pace with inflation, supporting consumer spending. Additionally, June 2024 CPI data shows that rent inflation has normalized, and core CPI excluding rent has declined for two consecutive months, indicating that inflation pressures are easing. This suggests that the consumer's purchasing power is stabilizing, which could support sustained consumer spending even with a lower savings rate. The normalization of inflation and expected rate cuts by the Fed could also boost disposable income, further supporting consumer spending.

• While bears claim that certain sectors, like business capital spending and the industrial sector, are in recession, it's important to note that these sectors are not the primary drivers of the current economic growth. The services sector, which accounts for the majority of GDP, continues to expand. Furthermore, the AI boom is leading to significant investments in technology and innovation, which could offset weaknesses in other sectors. Historical market performance data shows that gains typically beget more gains; strong performance in one quarter often leads to continued strength in the following quarter. This pattern could hold true even if certain sectors experience slowdowns.

• The increase in unemployment is relatively modest and still leaves the unemployment rate at historically low levels. Moreover, the labor market remains tight, with job openings still outnumbering unemployed workers. This suggests that the increase in the unemployment rate may be a temporary blip rather than a sign of broader labor market weakness. Historically, when the labor market is strong, it can help sustain consumer spending and economic growth even if other indicators soften.

Additional Points:

• The ongoing "AI bull market" began just before the release of ChatGPT in November 2022. Despite a 57.5% gain, it remains below the average bull market gain of 114%. Historical patterns suggest that bull markets are typically long and steady, and this one may still have significant room to grow.

• The AI boom has shown no signs of slowing down, with significant parallels to the internet boom of the 1990s. If this trend continues, the current bull market could have many more years of growth ahead, driven by technological advancements and sustained investor interest.

Given these mixed signals, attempting to time the market based on either of these perspectives could be risky. Instead, a measured approach, such as the slow dollar-cost averaging strategy we teach in the academy, is the best way to navigate these uncertain times.

Our method allows investors to steadily build their portfolios, mitigating the risks associated with market volatility, and ensuring that they are well-positioned regardless of whether the market continues to climb or if a recession does occur. By consistently investing over time, rather than trying to predict short-term market movements, you can prepare for whatever the future holds.