The case for no US recession is building, but some on Wall Street are cautioning against getting overconfident.
A plethora of softening data in recent weeks has pointed to a strong yet cooling economy. That has raised hopes among investors that the United States could avoid a recession despite the Federal Reserve's aggressive pace of interest rate hikes.
Bank of America economists said in a recent note that they expect the economy to keep expanding over coming quarters, with a gradual rise in unemployment.
"Our revisions imply we no longer expect a mild recession and, instead, think the economy may be able to skirt one," Bank of America economists led by Michael Gapen wrote in the report.
The July jobs report gave even more reason for Wall Street's optimism for a soft landing, or a scenario in which inflation comes down to the Fed's 2% target without a recession or a sharp economic downturn.
The US economy gained just 187,000 jobs in July, fewer than economists were expecting and extending the gradual cooldown seen in June's job growth, which was revised down to 185,000 jobs from 209,000.
JPMorgan Chase's top US economist said Friday he no longer expects a recession this year.
Noting that projections for third-quarter data suggest the economy is "expanding at a healthy pace," the banking giant is revising its position, said Michael Feroli in a note released Friday after the jobs report.
"Given this growth, we doubt the economy will quickly lose enough momentum to slip into a mild contraction as early as next quarter, as we had previously projected," he said.
Still, some investors are maintaining that the US economy could tip into a recession later this year.
Before the Bell spoke with David Donabedian, chief investment officer at CIBC Private Wealth US, about why he believes the economy, and markets, aren't out of the woods.
Before the Bell: It seems like a lot fewer people expect a recession now. What do you make of this?
David Donabedian: Our short term view has been that the market has gotten ahead of itself. So, the notion of a pause in this really oppressive rally, and even a pullback, is kind of what we've been preparing clients for in the short term. Not a descent into a bear market, but just a pullback in a market that has gotten ahead of itself and at least parts of which are somewhat overvalued.
There's always a reason. Valuation is not a market catalyst in and of itself. The Fitch news (of a downgrade to the US sovereign rating last week) maybe was an excuse for a little bit of a pullback.
What about your longer-term outlook?
We're somewhat cautious there as well. Our view all along has been that we're likely to have a recession that would begin sometime in the second half of this year, and we actually still think that's likely.
I don't think it's going to happen in August, but I think that a lot of people have forgotten the difference between coincident indicators and leading indicators. There's no question when you look at a lot of the economic data — it says, you know, the economy is not in recession. The economy is solid.
In other words, it would certainly be things like the GDP report, like in sales or consumer sentiment and others. But those give you an appraisal of how the economy is performing today, or more accurately, how it was performing last month. It's not predictive.
What do leading indicators show?
A lot of those indicators would suggest that we're due for some weakness in the economy, even though we don't see it yet. Certainly, the direction and magnitude of monetary tightening, the deeply inverted yield curve. The index of leading economic indicators is just kind of at an extreme rating.
So the point is, to the extent that the markets have sounded the all-clear on the economy, we would take the other side of that bet and say that it's going to get more challenging from my perspective, and that's going to feed into perhaps softer corporate revenues and profits than is generally anticipated in the second half of this year and into 2024.
The positive in that is that we've already seen a lot of progress on inflation. We think inflation will continue to come down here, and it ties back to that economic view I just provided — demand is likely to be weaker than expected. That will help inflation come down.
What's going to be the next test for stocks?
I think that the next test, and it'll be either sometime later this quarter or early fourth quarter, is going to be when the economic data goes from surprisingly good to surprisingly bad, and how the market reacts. So that's what I'm watching for.
One of the reasons for the rise in equity valuations in recent weeks was the pricing out of recession or economic weakness. Are we going to go through a period where it gets priced back in?
The counterweight to that is, if I'm right and we get that period of economic weakness, it will probably also increase bets on how quickly and by how much the Fed cuts rates, which is ultimately positive for equities. But I think the first reaction is probably a softer equity market.
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