The Recession Is Already Here & That Means The Time For Treasuries Is Coming
There’s some pretty clear evidence that the global economy is slowing, probably rapidly, and there’s likely more pain to come.
If you look at the latest economic forecasts, a fair number (but the minority) feel that a recession could come by the end of this year. About 80% or so feel that a recession will arrive sometime before the end of 2023.
I think it may already be here.
The U.S. GDP fell by 1.6% in the first quarter of this year. The Atlanta Fed GDPNow model, which is widely followed as “the” GDP forecast, is now projecting that Q2 will see GDP decline by 2.1%.
Two consecutive quarters of negative GDP growth is the traditional definition of a recession. If that number turns out to be true (or really even comes close to it), a recession would technically already be here.
The short-term and trailing economic numbers make the economy look like it’s still in decent shape, but the forward-looking numbers don’t.
The housing market is beginning to bust pretty quickly. Inventories are rising, the number of cancelled contracts for new home constructions is soaring, housing costs have risen significantly and listing prices are getting slashed. The manufacturing sector is contracting. High inflation is reducing discretionary spending. Commodities prices are falling across the board.
That’s some pretty clear evidence at this point that the global economy is slowing, probably rapidly, and there’s likely more pain to come. I threw up a graphic on Twitter last week talking about the behavior of Treasuries and utilities relative to the S&P 500. When rare events start taking place, you know that something is disconnected. When something is disconnected, there’s a higher probability that a drawdown event could occur.
Here’s the graphic I put up.
Two weeks ago, Treasuries and utilities both outperformed the S&P 500 by at least 5% in the same week for just the 8th time in the past 20 years. The other 7 instances occurred during either a market correction or an outright bear market. The fact that both asset classes turned around UNDERPERFORMED the S&P 500 by 5% each last week underscores what an unsettled market this is right now.
That’s why I’m a big believer in Treasuries here.
Treasuries have gotten slammed this year, mostly due to the Fed’s rate hiking cycle and the bond market repricing accordingly. But with recession risks looming, there’s going to come a time, probably soon, where investors start fleeing to Treasuries for safety. That’ll occur when interest rate expectations have peaked and the markets start looking forward to the next Fed rate cutting cycle. I think that probably happens at some point during the 2nd half of this year when inflation starts coming back down.
I think it’s important to point out that Treasuries are likely to remain volatile in both directions until both inflation and expectations of the Fed start to settle down. Once Treasuries are viewed as a safe haven again and recession risk creeps higher, I think a move back to a 2% 10-year Treasury yield is quite possible. Anything at or above 3% on the 10-year is probably a good entry point.
I think this could be the spot where investors make money over the next 12 months.
With that being said, let’s look at the markets and some ETFs.
Previous high fliers, energy and materials, are now the weakest sectors in the market. Both are responding to a rapid decline in commodities prices covering everything from natural gas to industrial metals to agriculture. On a valuation basis, I think both sectors are still looking reasonable and both appear neither overvalued or undervalued.
Healthcare is still the leader here and the only sector trading above its 50-day moving average. Its defensive peers - consumer staples, utilities and REITs - are in neutral territory and taking a break after leading the market over the past 6-7 months.
Growth, momentum and high beta names finally got a good week. As we’ve seen throughout 2022, we need to see some follow through to feel more confident in calling this a pivot. These sectors are firmly back in neutral territory, but I wouldn’t count on a comeback just yet. Earnings season looms.
On the tech side, blockchain is easily the most volatile subsector in the marketplace today. Single week swings in excess of 10% have become relatively common, although investors haven’t been jumping on board. Net flows are still negative as they are across most tech groups.
Consumer discretionary stocks had a nice week, but I wouldn’t bank on a recovery. The macro picture remains decidedly negative and I’m expecting we see a significant downgrade in both sales and earnings for many of the retail names. It’s already happened with Target and we’re likely to see a similar sentiment from its counterparts.
Energy and materials stocks continue to have a very rough month. Energy is still well in the green year-to-date, but the outperformance that had been building up in materials has completely evaporated and then some. Precious metals miners have been hit especially hard, but nearly everything linked to the commodities space has suffered.
Financials could be an interesting play heading into earnings season. Lending has remained tight, which could help insulate some of the banks from more unfavorable results in the 2nd quarter. Many of the big banks have leaned heavily on the investment banking and trading sides to drive revenues. The IPO market has been virtually non-existent in 2022, but trading has been alive and well. I think there might be a few upside surprises in bank earnings that could cause a quick pop.
Relative strength appears all across the healthcare sector, but the more speculative sector plays, including biotech and genomics, have made a strong comeback. These have been the market’s best performing groups over the past month, which is a little curious given the negative sentiment surrounding the financial markets. Overall, this sector still looks favorable.
I added bitcoin to the “commodities” bucket this week following last week’s 12% gain. The greenback and its parabolic rally is still the standout. This is good for dollar-denominated assets, but maybe not so much for U.S. corporate earnings. We’ll find out over the next month or so. Copper is still looking ugly and exhibit A in the argument that the economy is declining quickly.
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