Turn your TV to the financial news today, and it won’t take long before someone says the risk of U.S. and a global recession is rising. Many economists and pundits are arguing that a recession could arrive as soon as this year, and everyone is citing the same headwinds – out of control inflation, a Federal Reserve that was too late to raise rates and is now certain to choke off growth with monetary tightening, and continued disruptions to commodity markets that will impact consumer spending and corporate profits.1
This narrative is becoming pretty widespread. According to a survey of economists conducted by The Wall Street Journal, the risk of recession in the next twelve months is 28%, up from 18% just two months ago.
The International Monetary Fund (IMF) is also feeling a bit gloomier about the outlook – Managing Director Kristalina Georgieva is poised to cut growth forecasts for 143 countries representing 86% of global GDP. Georgieva’s rationale for slower-than-expected growth is, you guessed it, rising commodity prices and trade issues. These pressures globally could impact household spending, squeeze profit margins, and create a significant impact on net food importers like emerging markets countries in the Middle East and Africa, the IMF says.
The sentiment is souring, but there is a silver lining here that few are acknowledging. Even though the chorus in financial media today is for flashing recession signals, those same economists still expect inflation-adjusted U.S. GDP to go up by 2.6% in 2022, which is higher than the average annual growth rate for the decade leading up to the pandemic. There seems to be a great deal of worrying about an economy that people are also admitting is quite strong! If the base case is that the recession is likely to arrive in 2023 or 2024, I think that’s too far into the future to be a reliable prediction.
There is also a mixed track record for these economist surveys. The last two times the risk of recession was around 30% (as per the survey) were in August 2011 and September 2019. The August 2011 concerns about the economy were essentially dead wrong. 2011 was the second year in a decade-long economic expansion. September 2019 also seems like it would have been wrong had it not been for the pandemic in early 2020, which no one was factoring into their forecasts.
My take on the matter is that I see the U.S. economy growing firmly in 2022 (perhaps in the ~3% range), and if I was asked to forecast 2023 and 2024, I wouldn’t – it’s too far away, and we need more time to see how economic fundamentals shape up. This year I think the strong jobs market, rising wages, and consumer households in good shape will be plenty to overcome inflationary pressures that I think are poised to abate in the second half of the year.
On the U.S. corporation side of the equation, S&P 500 companies have collectively reported profit margins of 12.18% over the past 12 months, which is significantly higher than historical profit margins. In fact, there have only been three years since 1999 when corporate profit margins reached double-digits – 2006, 2018, and 2019. And even in those three years, corporate profit margins never even reached 11%. The figures for 2021 shattered those records and also represent the highest after-tax corporate profits relative to GDP that have ever been recorded (records date back to the 1940s).
One might expect that corporate profit margins have peaked, particularly in this more challenging economic environment, but signs indicate there may be more room to run – S&P 500 companies are expected to generate net profit margins approaching 13% in 2022, as companies raise prices slightly and focus on investment that increases productivity. The strong profit outlook has led analysts and companies to raise – not lower – corporate earnings expectations for the fiscal year 2022. If there is indeed a risk of recession, it’s difficult to argue that it will arrive this year. And for investors, that’s what matters most right now.
Bottom Line for Investors
Anytime I see ‘experts’ and the media align on a common set of worries and skepticism about the economy when in reality the economic fundamentals are strong and very underappreciated, it just makes me more bullish. The stock market moves on reality versus expectations, and low and falling expectations just mean the economy and U.S. corporations have a lower hurdle to clear for delivering a positive surprise. That’s what I think we’ll see in 2022.
Disclosure
1 Wall Street Journal. April 10, 2022. https://www.wsj.com/articles/recession-risk-is-rising-economists-say-11649592002?mod=djem10point
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