From Doom to Boom: Analyzing Economic Predictions and Uncertainty in the Stock Market

Throughout the summer of 2023, and even into Thanksgiving of last year, many frequent purveyors of doom, crashes, and economic collapses where messaging that the American economic landscape was a looming disaster.  A repeat of the 1987 stock market crash, an echo of the Great Financial Crisis, or even the second coming of the 1929 Depression was around the corner.  They were certain of looming disaster to begin in the 4^th quarter of 2023 or sooner, and one should dump all their stocks.  I would say that nearly half of sell side strategists and economists on Wall Street were parroting a looming recession in 2023.  Possibly closer to 90% of the $99 per year newsletter writers were spewing their stories of doom and fear throughout the year.

When you turned on CNBC, Fox News, or Bloomberg and it was a frequent back and forth debate between a hard landing for the economy and stocks or a gentler soft-landing outcome in economist terms. A hard landing is usually referred to by investors when, after a period of Federal Reserve interest rate increases, in order to cool inflation, or slow the pace of economic growth, the Fed goes too far in its actions and causes a recession. The 1970’s had numerous hard landings.  And more recently the Post Dot.com period in late 2000 ushered in a hard landing as did the period in late 2007 through early 2009.

Central banks aim for a soft landings in the economy when they raise interest rates to curb inflation. However, our Federal Reserve has a pretty bad track record in accomplishing soft landings during past rate hiking cycles.

The classic example of a soft landing, that is the “Goldilocks outcome” was the monetary tightening conducted under Alan Greenspan in the mid-1990s.  During 1994, the Fed raised rates seven times, doubling the federal funds rate from 3% to 6%. Then in 1995, they cut the federal funds rate three times when it saw the economy softening more than required to keep inflation from rising. Here is a table from Investopedia on the last 60 years of Fed interest rate cycles and the Hard vs. Soft landing outcomes.

Why do investors care about these things? Why are we subjected to the back and forth of soft-landing vs hard landing debates? Because, history has shown that over time frames of 12-24 months, hard landings can be very negative for stock returns.  Looking back over the history of hard landings and recessions, it’s quite normal for stock indexes to decline -30% to -40% in a run of the mill recession.  Stocks have declined  even more in very bad economic periods like the great financial crisis of 2007 through mid-2009.

Investors, recall that in the 1^st half of 2022, under a relatively strong economy in the US, stock indexes such as the S&P500 declined over -27.5% in nominal terms and -35% in real terms as the US stock market experienced an earnings recession for the first 2 quarters of 2022. Investors worry about these things because stocks anticipate both better outcomes and worse economic growth before the data is reported on by lagging government sources.

Into the noise of impending 1987 crash replays in late 3^rd quarter of last year, our Oak Harvest investment team was quite positive on equities into the late October 2023 selloff.  Here’s a link to our livestream with Troy, Charles, and myself, on Thursday Oct 26^th, into what turned out to be the lows for 2023 and the last 4 months.https://www.youtube.com/watch?v=yR4A1XTBO54

For many of the same reasons our investment team was confident last summer that we weren’t in an AI bubble yet, we were also confident that the US economy was NOT, I repeat not headed for a hard landing in 4^thquarter 2023 or the first half or 2024. We were confident that the quite normal late fall, early winter selloff was a buying opportunity for a rally in the S&P 500 to conservatively 5000 into mid to late March 2024 and more optimistically 5150-5200.

Now that most negative wall street economic bears, who had been forecasting a hard landing many times the last 12-18 months and lower stock prices, have finally thrown in the towel, and gone bullish, where do the indicators we follow stand?  And what does the mid-year and rest of 2024 look like? Where do these indicators stand versus calling for a hard or soft landing from here?

Let’s look at a few real time charts.  We don’t need to wait around for government data.

First, the US economic surprise index, which we’ve talked about before. Here it is.

This is the index that sums economist forecasts for different data series and then plots whether the reported data is exceeding or missing economist expectations.  As you can see, this data series exhibits a normal seasonal upturn in the first quarter as those cautious or dower economist forecasts have been bettered more often than not.  However, note the recent peak in the data series is both earlier and lower than previous first quarter peaks. That’s a bit of a warning sign behind the scenes for second and third quarter economic growth. Dire? No, just probably not as rosy of an outlook for summer as those talking on TV are trying to imply.

The second real-time chart is the market’s expectation of inflation over the next 10 years.  Inflation is the boogieman that the Fed has been trying to slay for the last 12-15 months. As one can see the 10-year expectation has dropped from its peak over three back to around 2.25%.  This happens to be the upper bound of its range for the better part of the previous decade. The market believes the Fed will get the inflation fight won over the coming few years.

However, the third chart here is the market’s expectation for inflation over the next year.  This is the 12-month inflation BE rate.  As you can see, it dropped from a peak of near 6.25% in late 1q22 to about 1.5% in late 2q23.

Our team had previously forecast inflation readings to rise in the 1q24 as those readings are very seasonal in the USA. As one can see, it has risen sharply since that low and is now approaching 4% again. Ouch!  That’s bad news if the Fed is watching this shorter-term data.  However, the good news is that this should be near its peak once again in terms of price and time for short term inflation readings.  That would be a positive checkmark on the ledger for continued soft-landing economic and stock action in 2024.

Finally, I’m going to go back to look at our old friend, real interest rates. This is the one that strategists on TV finally started to discuss as important and being a big part of the “higher for longer” bearish outlook they had in the second half of 2023.  Recall those academic discussions around “R-star”?  Remember those debates on TV, right as it turned out to be a positive tailwind for stocks?  Remember investors this is the component of Treasury yields that goes a long way in determining the PE ratio of stocks and the overall equity risk premium. A lower trending real rate is initially good for PE’s and the market and particularly for higher growth stocks.

It’s not a coincidence that growth stocks bottomed in late 2023 and have rocketed higher as the real rate broke its 15-month uptrend and headed lower. Here’s the 2-year real rate.

It’s heading down and to the right as well, which is initially good for growth stocks. The 1-year rate has a similar pattern to the longer ones, however it is now getting more concerning to me.  See the one-year real rate has fallen from 4% back in late 3q23 to under 1% currently.  To me that says that the market sees a dramatic slowdown in real economic growth coming in mid-2024.  To me that says the long and variable lags that economists talk about all the time, are finally upon us in the USA and that the Federal Reserve is not to lose with monetary policy, but rather too tight.

In fact, this chart of a real growth slowdown is another economic chart that yes, happens to be mirroring the path of the Dot.com internet buildout from late 1998 through mid-2000.  And we know how that economic period ended as the Fed turned the screws tighter on the economy right as it was already slowing.  The Fed helped cause a very hard landing in 2001.  Here’s the chart of the 10-year real rate into the economic top in the first half of 2000 and its subsequent path over the next year as the economy slowed and the Fed

Stayed too tight for too long and caused a hard landing in late 2000 and in 2001.

Investors, we are in a soft landing and have been for over a year now.  That’s exactly why stocks have rallied to make new ATH’s as our team has expected.  The $65 trillion question is how long will this soft landing last and are there early, predictive signs behind the scenes that we can see as investors that we are closer to an economic top and rollover which will inevitably lead us to a recession?  A recession that will cause stocks to drop over 30%. Because yes investors, it’s safe to say that Janet Yellen will be proven wrong that we will eventually have another recession in the US, and we will have some sort of financial crisis over the coming decade.

Right now, our team doesn’t have any definitive thoughts on when or how a recession comes so we are sticking with picking stocks for our clients in single stock accounts.  I can say, the math I see behind the scenes, the same math that said 5150-5200 on cash S&P500 optimistically into mid-March 2024 over a year ago, says that should the Fed glide the plane to gentle landing late this year, that S&P 500 over 6000 is possible in the 1h2025.  At the same time, that math also says that a hard landing in late 2024 or 2025 puts the S&P 500 back at 3500, or lower.  I know that’s not comforting or a great look, but as Tom Cruise says in his movie Maverick, “It’s the only look I got”.

For investors or retirees uncomfortable with this wide range of possible outcomes, the Oak Harvest team has launched a new strategy that retains the ability to go long stocks, short stocks, as well as buy partial hedges for a stock portfolio.  Information on this exciting new strategy of ours can be found at OakHarvestFunds.com.  From the whole team here, thank you and have a great weekend.

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