To my clients:

Three availability announcements. First, I’ll be away from the office next Friday and will be sending my weekly update a day early on Thursday, August 4th. Second, I’ll be taking a vacation week from Monday, August 29th through Friday, September 2nd with no update that week unless circumstances warrant. And third, I’ll be taking one more week off sometime earlier in August, although the specific dates are not yet certain (I’ll let clients know as soon as I do). I’ll have connectivity at all times, and will be following events from afar, although I’ll only be checking in sporadically via remote access.

It was an up week for North American stock markets with the Canadian TSX finishing up 3.7%; the U.S. Dow Jones Index up 3.0%; and the U.S. S&P 500 up 4.3%.

This was a week chock-full of significant developments. I’ll focus on the most important three.

First, let’s begin with what is surely the most headline grabbing development of the week: the second consecutive quarter of U.S. GDP contraction. The just reported (yesterday) 0.9% annualized contraction in GDP for Q2 follows the revised 1.6% contraction in Q1. A widely followed rule of thumb suggests that recessions occur when there are two consecutive quarters of GDP contraction. But I emphasize that this is a rule of thumb. Rules of thumb don’t always apply in all circumstances, and I’d be very surprised if the rule of thumb is relevant in this case. I don’t want to excessively dig around in the weeds and lose my audience, but here are a handful of reasons why the rule of thumb seems highly suspect in this instance:

- It is actually the National Bureau of Economic Research that dates recessions and, when doing so, it looks for a slowdown in economic activity that is deep, diffuse and lasting… two consecutive quarters of GDP contraction is not a stated requirement.

- Deep? This seems hard to rationalize, especially given the fact that the Q1 contraction owed almost entirely to trade imbalances in that merchandise was in demand during Q1, but it couldn’t be delivered owing to supply chain disruptions. Further, during Q2, industrial output rose at a 6.2% annualized rate. Further still, BOTH retail and wholesale sales are still at levels well ABOVE pre-pandemic levels.

- Diffuse? 1.1 million new jobs were added during Q2, including 372,000 most recently in June. Unemployment is near all-time lows. Recession has never occurred against this sort of employment backdrop.

- Lasting? Well, it’s not even certain that the two quarters of consecutive GDP contraction will remain as fact. Calculating GDP for the largest economy on earth is a complex and time-consuming job and is prone to often material revisions. There will be two more revisions to the Q2 GDP data in August and September. It’s entirely possible that the first estimate of Q2 contraction might be revised to a positive reading once the revisions are calculated in the months ahead.

To these points, in his press conference on Wednesday, Federal Reserve Chairman Jerome Powell said he did NOT think the U.S. was presently in recession. He cited many of the reasons I referenced above for this belief, focusing particularly on the strength in employment. President Joe Biden also argued the same (although admittedly his perspective is somewhat more circumspect given the political consequences of leading the U.S. during recession).

So no, I too do not think the U.S. is presently in recession. Might it get there? Yes, that is absolutely possible. RBC’s 7-point recessionary scorecard could best be characterized as forecasting a 50/50 probability of U.S. recession at present. But once again, harkening back to my client conversations in June, if recession were to occur, it seems destined to be mild and perhaps already fully priced in by markets at the June lows.

The second development I’d like to focus on is the press conference by Jerome Powell referenced above. The U.S. Fed raised rates by 0.75% for a second consecutive meeting. At 2.25 – 2.50%, U.S. interest rates now stand roughly in the middle of the 2.0 to 3.0% “neutral” range which is widely considered as neither stimulative nor restrictive to the economy. But during his press conference, Powell used verbiage that strongly hinted that a Fed “pivot” may be looming. By this, I mean that Powell would no longer provide guidance as to the future path of rates, but instead said the Fed would react to data on a meeting by meeting basis. So while this certainly leaves the door open to further rate increases, it was directionally positive for sentiment in that the overtly guided path to increased rates had been removed. With the next Fed meeting not until September, the Fed will have two inflation reports to evaluate between now and then which theoretically should offer heavy doses of the “data” they will be evaluating when making their decision. As I’ve commented in recent weeks, it would seem inflation is destined for some material declines in these two reports given the significant decline in commodity prices in July.

And third, I’d like to superficially comment upon corporate earnings. Based upon market declines during the first half of 2022, it would seem investors were being driven by recessionary fears and the types of steep declines in corporate earnings that inevitably accompany economic downturns. But so far during the current quarterly earnings season these fears seem to be unfounded. In the face of high inflation, supply chain bottlenecks, lingering covid concerns and shifting consumer demands from merchandise to services (in this instance, think of people buying trips and experiences over goods and things), corporate earnings are coming in far better than feared. Has there been slowing in earnings growth? Yes. But not as much slowing in growth as markets were forecasting, and certainly lightyears better than outright losses seen during the Great Recession of 2008.

So, to put it all together, media headlines are sure to continue focusing upon a here-and-now recession as “revealed” by the two consecutive quarters of contracting GDP reported this week. But notwithstanding the flaws in that rule of thumb approach to identifying recession, it remains the case that markets are forward-looking, and this week saw this forward vision focused upon a potential Fed pivot on the interest rate front and the continuing health of corporations. Hence it was another nice week for portfolio returns.

That’s it for this week. My next update comes Thursday, August 4th. All the best,

Nick

Nick Scholte, CIM, FCSI

Senior Portfolio Manager

Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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