The Federal Reserve’s annual Jackson Hole Symposium wrapped up on August 26, 2023. The main takeaway is that central bankers are unsure whether they have raised interest rates enough to bring inflation down to their two percent goal.
I had been in the camp that the July 26, 2023 federal funds rate increase of one-quarter percentage point would be the last of this cycle. I’m no longer as confident in that assertion. The futures market assigns about a 55 percent chance of a rate hike at its November 1, 2023 meeting (skipping the September 20, 2023 meeting).
Those odds are understandable, given that the economy seems to be running hot. The Atlanta Fed GDPNow model is currently tracking at 5.9 percent. That tracking rate will come down to a sub-four percent figure, but that is still above trend and dangerously high if the goal is to reduce inflation.
Over the last 20 months, the dialogue about the effect of higher interest rates on the U.S. economy has shifted from a nearly definite hard landing to possibly a soft landing. Then some economic pundits began arguing that there would be “no landing” (i.e., no recession). Now a growing contingent is predicting a new economic boom.
As the consensus sways to believe Goldilocks is here, I think there is a roughly 50/50 chance a recession will start in 2024. ”Capital Ideas” readers know me to be often contrarian. In mid-2022, I presented at a conference where I was derided by other speakers and attendees because I argued that a year from then, the S&P 500 would be up about 10 percent. They all thought the world would fall apart and I was naïve to ignore the current negative data. Their gloomy outlook made me feel more bullish. (I presented at the same conference a year later, and I didn’t try to rub their nose in it; they knew they were too pessimistic.)
The crowd is not yet at such an optimistic extreme it worries me. But I can envision a point in the not-too-distant future when the crowd sees nothing but clear skies ahead. It is at that time that I will pull out my umbrella.
Up until now, I have had few, if any, concerns about the U.S. Treasury inverted yield curve. A yield curve inversion occurs when long-term rates yield less than short-term rates (the opposite is typically true). An inverted yield curve often portends an economic recession. Now that the talk of a boom is growing, those who banged their chest the loudest about the inverted yield curve signaling a recession have been thumping more quietly. It is an appropriate time for me to remind them that we ain’t out of the woods yet.
The yield curve achieved its 300-day milestone on August 23, 2023.
The initial inversion occurred on October 27, 2022. And the maximum conversion (so far) occurred on May 3, 2023. Historically, it has taken an average of 589 days since the initial inversion and 395 days from the trough inversion to reach a recession. From both dates, that tracks to a downturn starting in June 2024.
The median return of the S&P 500 from the trough inversion until the start of the recession has been 3.89 percent.
Its average maximum gain (excluding the outlier during the technology book of the late 1990s) has been 13.3 percent. That would put the index near its 2022 peak. That would be about a five percent return from current levels.
What will the stock market do for the rest of the year?
Since 1928, there have been 33 years in which the S&P 500 was up 10 percent year-to-date. The average return for the last four months of the year was 5.45 percent, with positive returns 81 percent of the time.
That 5.45 percent gain would bring the S&P 500 close to new a level not seen for two years. That level would be consistent with the earlier mentioned 13.3 percent average maximum gain after a yield curve inversion trough. Could the S&P 500 reclaim its January 2022 highs in January 2024?
However, suppose sentiment indicators are overly optimistic while the market reclaims its old highs. In that case, it would be a contrarian indicator for me and a signal to get out of the market in anticipation of a 2024 recession.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
