Is the economy at a tipping point?

Is the economy at a tipping point?

Inflation, rising interest rates, market volatility and talk of a new recession. That’s been the story of the financial markets almost all year. The only thing that changes is the intensity – and after a calm May, things intensified again in June. What does it all mean heading into the busy summer spending season? In this blog, I’ll cover:

Where we are and how we got here.

Why many think a recession is inevitable.

When it may hit and how bad it may be.

And how to help protect yourself.

Let’s start with where we are and how we got here.

• Fears of a new US recession have been building all year due to the Fed’s efforts to try to curb inflation by raising short-term interest rates for the first time since 2018.
• Most analysts agree the Fed waited too long to take inflation seriously, and now they’ve put themselves in a no-win situation. If they move too cautiously inflation may continue getting worse. If they move too aggressively, they could trigger a recession.
• With the current pace of inflation now at a 40 year high of 8.6 percent, it’s all but forcing the Fed to be aggressive.
• That’s why on June 15^th the Fed instituted its biggest single-meeting rate hike since 1994: three-quarters of a percent, bringing the current Fed Funds rate up to a range of 1.5 to 1.75 percent.
• Forecasts now indicate that rate will double by year’s end as the Fed continues moving aggressively forward – most likely starting with another three-quarter percent bump in July.
• In addition to the big rate hike on June 15th, the Fed also downgraded its projections for the economy: The Federal Open Market Committee now anticipates the unemployment rate will come in at 3.7 percent by the end of this year versus the 3.5 percent rate it projected in March. It also lowered its forecast for real GDP growth from 2.8 percent to 1.7 percent.
• As investors digested all of this and tried to gauge its near and long-term impacts on the economy, the stock market – which had already entered bear market territory – dropped.
• The S&P 500 fell by more than 3.4 percent before paring some losses, and the index reached its worst intraday level of the year. The Nasdaq declined by 4 percent, bringing the index down as much as 32 percent on an intraday basis for the year-to-date. The Dow sank by more than 800 points, or 2.6 percent.
• Meanwhile, the 10-year Treasury yield dropped to about 3.34 percent from a peak of 3.48 percent, its highest level in 11 years.
• This drop in the 10 year indicates another flight to quality occurred, in which many equity investors fled the stock market for the relative safety of the bond market.
• Does all of this mean a recession is inevitable? I’ll talk more about that shortly.

So far, we’ve looked at where we are and how we got here. Now let’s focus more on the possibility a new recession.

• After approving its biggest short-term interest rate hike in nearly 30 years and downgrading its economic forecast, Fed Chairman Jerome Powell said outright that the central bank is not trying to induce a recession.
• That may be. But while lowering interest rates can help curb inflation, the strategy also – by its nature – slows economic growth.
• That’s risky because growth has already been slowing on its own for some time.
• In fact, the GDP not only didn’t grow in the first quarter, it shrank by 1.4 percent – although that had more to do with the trade deficit than consumer spending.
• Still, if the GDP shrinks again in the second quarter, we will, by definition be in a recession.
• Even if it doesn’t start that soon, many believe a recession is unavoidable.
• Recently, Deutsche Bank became the first major bank to forecast a US recession for next year.
• Most investors share the same gloomy outlook. According to a recent Bloomberg survey, 48 percent of investors expect the US to fall into recession next year.
• Another 21 percent expect the downturn to happen in 2024, while 15 percent expect the recession to come as early as this year.
• One top investor was even more blunt. Michael Novogratz of Galaxy Investments told MarketWatch recently: “The economy is going to collapse. We are going to go into a fast recession, and you can see that in lots of ways.”
• Novogratz cited a struggling housing market, increasing layoffs in many industries and the Fed’s no-win strategy as signs that a recession is imminent.
• But what will determine whether the recession hits sooner or later? I’ll talk more about that shortly.

Now let’s talk a bit more about when a recession might hit.

• At the moment, I still agree with those who believe a recession is likely to hit sometime in 2023. The markets are forward looking, and typically try to foresee economic conditions around six to twelve months ahead.
• But given all that has happened in the past few weeks – with inflation getting worse, the Fed getting more aggressive and Wall Street dropping well into bear market territory – it’s also possible we could be at a tipping point that triggers a recession this year.
• The market is down around 20 percent now, but there are signs it could sink by another ten percent or more.
• If the market gets down to a drop of 30 percent or more, it could create the reverse wealth effect. The wealth effect is the tendency for people to spend more when the market is up and their brokerage accounts and 401ks are doing well. Even if their income hasn’t increased, they tend to spend more because they feel wealthy, and this fuels economic growth.
• The reverse wealth effect is just the opposite. Even if their income hasn’t decreased, they feel poor because their investments are struggling, so they start spending less. If spending shrinks to a level that the economy contracts again in the second quarter like it did in the first, we’ll be in a recession this year.
• Some analysts now see that additional market shrinkage as a real possibility. Morgan Stanley recently said the S&P 500 could easily slide by another ten percent from its current level to as low as 3,400 points.
• This would be one of those instances where a falling stock market helps trigger a recession rather than the other way around.
• What will all of this mean for your investments, and what can you do to help protect yourself? I’ll talk more about that in just a bit.

Now, let’s talk about how to help prepare and protect your money.

• Obviously, a recession can affect your finances in many ways. Inflation means you need to stretch your income further. Volatility in the stock and bond markets can mean your investments are worth less. And if you’re still working and get laid off, obviously that’s a worst-case scenario.
• It’s no wonder that a recent CNBC survey found that 81 percent of Americans are worried about the next recession.
• Your ability to get through a recession with little hardship and no lasting financial damage depends on many things – starting with being prepared.
• That’s especially important if you’re retired or nearing retirement. You don’t ever want to be in a position where you’re drawing retirement income from your principal when the market is shrinking. That’s a sure way to cannibalize your entire nest egg and eventually run out of income.
• You want to help ensure you’re using strategies that help protect your principal and allow you to satisfy your income needs from interest and dividend return: to live off the eggs and never hurt the chicken.
• With many of these strategies, that return is often guaranteed at a fixed rate even if the value of your principal temporarily shrinks due to rising interest rates like we’re seeing now, provided there are no defaults.
• In March and April, many individual bond investors saw their values down by 5 percent or more, but their income return was not affected.
• And eventually their values will recover and start growing again – just as they did in 2019 following another year of interest rate headwinds caused by the Federal Reserve.
• For investors with a higher risk tolerance, staying in the stock market is okay if you have a strategy geared toward dividends rather than capital gains. Even in a recession, many companies remain profitable and continue to pass on part of their profits to investors in the form of dividends.
• Another benefit is that when interest rates go up, these companies often tend to be less negatively affected than those that don’t pay dividends. This can help minimize your losses in a well-balanced, diversified income portfolio when all the markets are struggling.
• Even if you’re already investing for income, now is a good time to revisit your portfolio with an income specialist to determine if you can make changes that will help you better weather the coming recession storm.

If you’re close to, or in retirement and you’re concerned about your money, it’s essential that you stay informed and up to date. And right here is where you can do it. Contact Arbor Financial at (321) 795-4799 any time for a free consultation and stress-test on your money.

Investment Advisory Services offered through Sound Income Strategies, LLC, an SEC Registered Investment Advisory Firm. Arbor Financial Services of Florida, Inc. and Sound Income Strategies, LLC are not associated entities. Arbor Financial Services of Florida, Inc. is a franchisee of the Retirement Income Store. The Retirement Income Store and Sound Income Strategies LLC are associated entities.