“You make most of your money in a bear market, you just don’t realize it at the time.” Shelby Cullom Davis
No process in the economy proceeds completely evenly, development always occurs within certain fluctuations. There are periods of growth, and there are periods of recession and slowdown – the so-called phases of the economic cycle.
Today, many are talking about a recession in the United States. The tone of the agenda may vary slightly, but the context is the same: a recession is a forecast for the near future or it is already an obvious established fact. But, in fact, this is not the first time recently. The risks of recession in the US economy arise regularly. The last most significant risk of the US economy going into recession was in 2018. Let's take a closer look and compare the recession of 2018 and the situation in 2022, find similarities and differences, and also try to assess the current state of the US economy. What is it: crisis, recession, stagnation or just temporary difficulties.
Indicators of recession in the economy
The phases of growth, decline, and stagnation in the economy are characterized by certain values of macro indicators and their mutual combination. The stock market as a reflection of the economy can act as an indicator of the passage of a particular phase of the economic cycle. But conclusions based only on market dynamics will not be objective, since the vector of stock movement is determined not only and not so much by fundamental factors. Especially in the short and medium term, market movement can be unpredictable and chaotic ("What affects the value of shares"). The actions of speculators and many other factors are involved here.....finally, purely the psychology of the investor (the instinct of the crowd).
Therefore, for the "diagnosis" it is important to operate with more objective indicators, such as:
- The GDP indicator.
- Labor market indicators.
- Business activity index.
- Inflation.
- The course of monetary policy.
Moreover, it is important to evaluate not only the current indicators, but also to identify the presence of dynamics and a stable trend, as well as to identify the causal relationship of these changes.
Read more: Causes of inflation and scientific approaches to their study
If we return to the situation with the United States, then in fairness it should be noted that neither in 2018 nor now there has been a recession in the US economy. But as now, so in 2018 there was a reasonable risk that the economy would enter a recession. At the same time, the situation in 2018 was very similar to the current situation. Monetary policy was tightening. In 2018, as well as now, interest rates were rising, and the QE (Quantitative easing) program was coming to an end. Moreover, the QE program was not just coming to an end, the US Federal Reserve was moving to actively reduce its balance sheet, that is, the same thing that we see now.
All these factors contributed to the fact that at the end of 2018, the most significant market correction developed in the US market after the global financial crisis of 2008.
So, let's look at what is common and what are the differences between the current situation and the situation of the second half of 2018. We will operate only with facts – clear statistics on the previously highlighted indicators.
US GDP
The main indicator of recession in the economy is GDP. The classic definition of a recession is when GDP declines, that is, it has negative growth rates for more than two consecutive quarters. Let's see what happened in 2018 and what we have now.
Dynamics of US GDP
So, we see that in 2018, in the 3rd and 4th quarters, the GDP growth rates slowed down significantly, but they were still not negative. That is, the economy was still growing, albeit at a much slower pace. According to the results of the 1st quarter of 2022, we see real negative growth rates, that is, a reduction in US GDP by 1.5%. This is the first signal: if the second quarter also shows negative GDP growth, then formally it will be possible to state a recession of the US economy.
However, it is worth noting that the forecast for further US GDP growth remains positive. Thus, the consensus forecast for the results of GDP for the 2nd quarter of 2022 is +2.2%. Therefore, it is worth carefully monitoring this situation. Positive rates are noted in the forecasts of all economic institutions:
- in the statement of the Fed meeting dated 06/15/2022, the estimate of GDP growth for 2022 was reduced from 2.2% to 1.7% yoy. Reduced, but remains positive.
- 07.06.2022 The World Bank has lowered its forecast for US GDP growth in 2022 to 2.5% from 3.7% YoY. Reduced, but remains positive.
But it is worth saying that the state of the economy and its prospects are characterized not only by the GDP indicator alone. Also of key importance is the state of the labor market, the growth rates of the industrial and service sectors, as well as the inflation rate.
Read more: What is macroeconomic statistics? Macrostatistics aggregators and their examples
US Unemployment Rate
This is the main indicator of the labor market. The labor market is one of the most important indicators of the "health" of the economy.
US Unemployment Rate
In this case, we see that both in 2018 and in 2022, the unemployment rate was at one of the lowest levels, which means that the labor market was stable, and the economy was creating new jobs.
The index of business activity in the manufacturing sector PMI USA
It is believed that if the value of the PMI index is less than 50, this indicates stagnation in the sector and a possible recession in the economy.
The index of business activity in the manufacturing sector PMI USA
We see that in 2018, the dynamics of the PMI index was negative. The index value was very close to the threshold level of 50. This meant that activity in the manufacturing sector was at an extremely low level. In the current 2022 year, we see that the PMI index shows much more positive dynamics. Its values are confidently above the 55 mark, which tells us about a fairly good level of business activity in the industrial sector.
Read more: What is the Overnight Interest Rate?
US ISM Services Business Activity Index
Just like the PMI index, the ISM index shows the level of business activity in the service sector. If the index value is greater than 50, this indicates sufficient business activity in the service sector. If the index value is less than 50, this indicates a decline in the sector and may be an indicator of the onset of a potential recession.
US ISM Services Business Activity Index
In this case, we see that the service sector in the United States feels about the same compared to 2018. Although in the current 2022 it is worth noting a more significant decline in the index, but to a greater extent this is due to the continuing covid restrictions in some states. In general, it is worth noting that the service sector index does not show signals of an impending recession.
Read more: What is shrinkflation?
US Inflation
Inflation is exactly what you can see the difference between the situation in the economy in 2018 and what we have now. In 2018, the correction in the stock market took shape against the background of absolutely normal levels of inflation, and inflation did not grow. Now we have record levels of price pressure in the US over the past 40 years.
US Inflation
In this case, what negative impact does high inflation have on the stock market? One of the factors of the frisky correction in 2018 was the tightening of monetary policy - a rate hike and the curtailment of the QE program. For the stock market, this is always a negative, since such actions mean that liquidity becomes more expensive and it becomes less.
Now high inflation is further spurring the Fed to raise interest rates more aggressively and reduce its balance sheet more actively. This is an additional factor of pressure on the markets in the current situation.
US Monetary Policy
Since December 2015, the next cycle of interest rate increases has begun in the United States for the first time since 2008. In 2018, the rate of interest rate growth was the highest, the rate was raised every regular meeting of the Fed. In toga, rates rose from 0% to 2.5%. Now the interest rate is also being raised, while the increase is proceeding at a more aggressive pace.
Dynamics of the Fed rate
At the same time, the high level of inflation gives us an understanding that the rate is highly likely to be raised further. And this rate hike will be sharper and more significant than the 2018 rate hike cycle. We saw the result of a more aggressive policy of rates at the June meeting of the Regulator. Its continuation is supported by the Fed's rhetoric. Market expectations of continued rate increases are reflected in the values of interest rate futures. Interest rate futures due in July 2023 indicate to us the probability that the interest rate by that time may be in the range of 3.75% – 4%.
Read more: The value of the Central Bank's Key Rate for the financial market
Also, in parallel with the interest rate increase, the QE program was curtailed and the Fed began to reduce the balance sheet.
At the same time, the rate of reduction of the Fed's balance sheet (sale of repurchased assets from the Fed's accounts) reached its maximum rate by the end of 2018. Now we see so far only the very first stages of reducing the balance.
Technical picture
The correction that is taking place in the US market now and which took place in 2018 are very similar in appearance and in scale.
The technical picture of the S&P500 index in 2018
The technical picture of the S&P500 index in 2022
In 2018, the US market correction for the S&P500 index was 20%, while at the moment, by June 2022, the correction for the index was 23.43%.
Read more: LIBOR: what does it mean and how is it calculated?
Conclusion
So, what conclusion can be drawn from the analysis of the past and current situation? In general, market corrections in 2018 and this year are taking place against the background of similar macroeconomic conditions. This is a decrease in GDP growth, a slight slowdown in business activity in the industrial sector and in the services sector, as well as similar actions of the Fed in monetary policy - raising interest rates and reducing the balance sheet of the US Federal Reserve.
However, it is worth noting that the current situation is developing in a tougher scenario relative to the indicators of 2018. Here we have not just a slowdown in GDP growth, but one quarter of its real reduction. An additional negative background is a very high level of inflation, which in turn allows the Fed to act more aggressively in terms of tightening monetary policy. In 2018, the cycle of monetary policy tightening was at its most intense phase, and at the moment we have only the initial phase of raising interest rates and reducing the Fed's balance sheet.
On the other hand, it is worth noting that the market correction that took place at the end of 2018 was also due not only to economic factors. Geopolitical tensions and the acute phase of the trade conflict between China and the United States have made a significant contribution to fears and tensions in the market.
But what interests all investors the most? This is when the correction ends and the markets move to growth.
It is also worth noting that against the background of high profit growth rates, the American stock market has one of the lowest investment estimates in terms of P/E over the past 12 years. And as we can see from the experience and history of past crises, real objective indicators of profitability and efficiency of companies have always outweighed expectations of a potential negative in the stock market.
Therefore, do not forget that any downturn in the market is an opportunity to profitably buy shares of companies that are interesting from a fundamental point of view.