Is the United States already in recession?

by Diana Wagner

How is the American economy doing? Facts, numbers, analysis and scenarios. Commentary by Diana Wagner, equity portfolio manager at Capital Group

Is the U.S. economy in recession or not? This is the question many investors are asking, given that the Gross Domestic Product (GDP) of the United States declined for two consecutive quarters in the first half of the year, a commonly recognized definition of recession.

However, with steady job growth, an unemployment rate at historic lows, and solid consumption growth, it doesn't feel like a recession that most people would remember. So what is the conclusion?

It depends on the interlocutor. With food, energy, and housing prices rising faster than wages, the average American consumer would probably say yes. In our view, either we are on the verge of a recession or we are already entering it.

The official arbiter of recessions in the US, the National Bureau of Economic Research (NBER), takes some time to express its opinion. The organization takes into account many factors in addition to GDP, including employment levels, household income, and industrial production. Since the NBER usually does not reveal its results until six to nine months after the onset of a recession, it is possible that the official announcement will not come before next year.

It's fair to say that most consumers probably don't care what the NBER thinks. They see inflation above 9%, energy prices rising sharply and home sales falling. They feel the impact of this data. The labor market is one of the only data that does not signal a recession at this time.

However, these numbers reflect an imbalance between supply and demand in an economy that has not yet fully recovered from the pandemic. More jobseekers are expected to return in the coming months. This should drive up the unemployment rate, as companies will reduce hiring.

Consumer spending, on the other hand, increased by 1.1% in June. On the surface, this is very positive, but adjusted for inflation it is basically flat. It also reflects the increase in spending on basic necessities, such as health care and housing, and hides the decline in discretionary goods categories such as clothing and leisure.

Another worrying sign is the rapid decline in new home sales. With the Federal Reserve's aggressive rise in interest rates to combat inflation, mortgage rates have skyrocketed in recent months, triggering a sharp reaction in the housing market.

Last month, purchases of new single-family homes fell 8.1%, the biggest drop in more than two years. Home ownership sales fell 5.4%, the fifth consecutive month of declines. In addition, the drastic rise in house prices during the pandemic raises concerns about a potential and painful correction.

If we are heading into a period of recession, the upside could be the return of the extreme inflationary pressures recorded in the last year. In fact, some argue that inflation has gone so out of control that a substantial recession may be needed to bring it back to the 2% target set by the Fed.

Are we therefore in a new inflationary regime? In our opinion, no. Consumer prices are likely to fall in the coming months due to recession and falling demand. In this case, the bond market may have weathered the worst moment, as the Fed is considering whether it can continue to raise interest rates in the event of an economic downturn. In fact, the bond market is already pricing in expectations that the Fed will cut rates several times in 2023.

There are many signs that inflation has reached its peak, such as the drop in gasoline prices since mid-June, wheat, corn and other commodities since mid-May. This could give the Fed the cover it needs to support economic growth, while continuing to take inflation seriously.

Meanwhile, we expect more volatility as the market adjusts to tighter monetary policy. As for portfolios, this means moving towards higher-quality investments, including US Treasuries and mortgage-backed securities, but also looking for opportunities in corporate and emerging market bonds, where investors are rewarded for the growing risk of recession.

Similarly, in equity markets, identifying high-quality companies with consistent cash flows and reliable profit margins is critical to overcoming recessions. Companies with solid and growing dividends are particularly attractive.

In this context, we are geared towards investing in companies whose fundamentals will hold up relatively better. Pricing power and demand stability are important elements.

We prefer a relatively concentrated portfolio, suitable for all seasons and able to perform in different market contexts. Our main holdings are healthcare, software and insurance companies. We are also considering consumer goods, but we need to be very selective in this area because some valuations have become quite high.