Q2 Cornerstone Investment Note: Recession or speed bump?

What a difference a year makes. This time last year, technology stocks were still enjoying the tailwinds of the remote-work/reopening trade as the decade-long bull market in growth stocks powered on. Then came rising inflation, rising interest rates, and a plunge in the technology sector that has yet to show signs of recovering.

So, after a first half of the year many investors would like to forget, what can we expect in the second half of 2022?

On one side, investors fear a severe recession, which has pushed markets downward since early in the year. At the same time, we’re seeing elevated earnings and revenues estimates for Q2. Market prognosticators are going back and forth on their intermediate outlook, with investors left in the middle trying to “work it out.”

The Bear Case

A recession is typically defined as two straight quarters of declines in real gross domestic product (GDP), meaning they typically start at a peak and end in a trough. Officially, recessions are determined by the National Bureau of Economic Research. The measurement process considers a wide range of indicators, including industrial production, nonfarm payroll employment, personal income and more.

Real gross domestic product contracted at an annual rate of 1.6% in the first quarter of 2022, according to a recent estimate by the Bureau of Economic Analysis. The Federal Reserve Bank of Atlanta estimates that the economy contracted by a seasonally adjusted 1.2% in the second quarter. If those estimates are accurate, we may be like the proverbial frog in a boiling pot, sitting in a technical recession already.

On July 13, the gap between 2-year Treasury yield and its 10-year counterpart reached its highest level since 2000. The yield curve inverted, which has long been considered a harbinger of a recession.

Moreover, the personal savings rate has dropped to 4.4%, its lowest rate since 2008, due to the increased food and fuel costs that have come with higher inflation. Along with dipping consumer sentiment and the drop in equities, this could contribute to declines in real consumer spending and retail sales. Recession is the conversation topic du jour, and the more we talk about it, the more likely a recession becomes, since all this bad news could lead to a drop in business spending and create a self-fulfilling prophecy.

Short-term pain, long-term gain?

Despite the recent bearish run, a bullish case has been slowly gaining steam at the midway point of 2022. Investors are parsing each new data release, hungry for any sign of a turnaround in economic data. That’s because when stocks emerge from a bear market, they have historically rewarded investors.

After soaring in early summer, oil prices are moving back down to earth as supply and demand are working back into balance. Corporate earnings have been largely positive as companies have started reporting for Q2. Insider stock purchases among S&P 500 Index companies from May 1 to May 24 was the strongest since March 2020, according to the Financial Times, which cited research from VerityData. And for companies in the Russell 2000 index, insider buying outpaced selling in May for the first time since March 2020.

Regardless of where you believe markets are heading next, the selloff in equities in the first half of the year has created a buying opportunity not seen in some time. If you’re an investor with a long-term horizon, now could be an auspicious time to purchase equities at a discount.

Inflation is the key

The central question for investors for the balance of 2022: Will inflation data continue to rise to the point that the Fed has no choice but to tip the economy into recession via aggressive rate hikes? Or will inflation moderate and allow the Fed to take its foot off the gas and avoid the worst possible outcome? The Consumer Price Index rose 1.3% in June, taking the one-year number to 9.1%, its fastest rate since November of 1981. The strong inflation data in June was widely expected. In the second half of the year inflation is expected to begin to moderate. What happens here will most likely dictate what happens in markets next.

Even if the U.S. finds itself in a recession , we don’t believe it is likely to be deep or lengthy. US economic fundamentals are inherently strong. Corporations and consumers are still well capitalized. As mentioned above, corporate earnings have been strong throughout this entire period and profit margins remain near historic highs. Supply chain disruptions continue to moderate which is slowing inflation across the economy; albeit with a lag. Areas like homebuilders, automobile production, capital spending and inventories remain stable.

The importance of having a process

Managing your portfolio during a bear market requires a different approach than what was effective during the bull market of the past decade. There is no rising tide lifting all boats – navigating volatility while the market resets requires the ability to find opportunities that others overlook.

Alternative investments have been a bright spot at a time when most other investment options have been challenged. In particular, private credit, private real estate, private equity, and real assets have helped blunt the impact of the stock market decline in 2022. That’s why we partner with a wide range of expert managers in these asset classes to provide clients with the best possible options.

Times like these require a long-term investing process based on your financial goals and risk tolerance, and the discipline to adhere to the process when others are fleeing for the exits. It’s critical to have emergency reserves when markets fluctuate, and to understand where your income is going to come from. Understanding your goals and what’s required to reach them can help you tune out the short-term noise and remain focused on your long-term objectives.

As always, if you have any questions or would like to have a conversation, please reach out to us or your portfolio manager.

 

The Cornerstone Team

 

 

Disclosure: Cornerstone Advisory, LLC, is registered as an investment adviser with the SEC. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment or strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals, and economic conditions may materially alter the performance of your portfolio.