February 13, 2023
Investment Strategy Brief: V-Day on Wall Street
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Below is a transcript of this week’s video:
Hopes for a soft landing have, understandably and predictably, grown at the start of the year. Why? Well, it should be no surprise that market participants want there to be no recession. But the Fed has given them a reason to believe — it has begun to slow its rate hikes, enticing some to believe this to be the end of the economy’s troubles. Unfortunately, this pattern of premature hope seems to occur in most market cycles, as it did in 2006 right before a relatively meaningful economic downturn. While this may not be a situation as nasty as the 2008 financial crisis, investors should be careful not to interpret hopes for a soft landing as an indication that a soft landing is definitely going to occur.
There is some reasonable reasoning behind these hopes, as a well-engineered soft landing can keep the stock market rally alive as shown by the experiences in 1994 and 2018. However, unfortunately, there are just as many if not more situations, such as the experiences in 2000 and 2006, in which the Fed overshot with its rate hikes and triggered a recession.
So, what creates a soft versus a hard landing? We think the Fed plays the part of Cupid, matching some rate hike cycles with a soft landing but not others. Using those past two examples of 1994 and 2018, in both instances the Federal Reserve raised rates until they reached their estimate of the neutral rate. In 1994, the economic expansion continued to grow and lasted until 2001. After the hikes in 2018, the economy also grew and might have continued to grow if it were not for the COVID pandemic, a phenomenon that cannot be blamed on the Fed.
By contrast, in the other three periods in 1989, 2000 and 2006, the Federal Reserve hiked rates above neutral and then kept them there for enough time to trigger the next economic downturn. Each had its own particular situation from the unravelling of the Saving and Loan Trusts, to the implosion of the 2000 tech bubble, to the unwinding of a housing and mortgage bubble. So, the message is that high rates have a knack for causing parts of the economy to break.
Here are some other common factors as well. Many recessions followed rate hikes that were piled on top of food and energy price hikes. While the rate hikes were meant to contain the inflation, they served as the second of a 1-2 punch to the consumer.
For businesses, rate hikes are often accompanied by more restrictive lending practices, making it harder and more costly to get business loans. As usual, we are seeing this during this cycle.
We think that it is for these reasons that Glenmede’s Leading Economic Indicator, which aggregates various leading economic data to give us a modest lookahead to likely growth trajectories, continues to point to an economic growth scenario that is considerably slower than recent experience if not recessionary.
- Hopes for a soft landing have understandably grown as many would like the market recovery to continue.
- Such hopes, brought on by the Fed slowing its tightening cycle, may prove premature as the full impact of past rate hikes has yet to be felt.
- Despite the naysayers, the Fed has engineered soft landings before, but never with rates well above their own measure of neutral.
- The combined impact of higher prices, higher rates and tighter lending standards are likely more than enough to eventually stall the economy.
- Investor should maintain a defensive allocation relative to their longer-term plans until markets better reflect economic weakness.
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