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This Is Not A Recession

The S&P 500 is down 11% through February 11th, and questions about the health of the economy are increasing. There seems to be a “consensus” that we are facing a recession, so it is into these opinion-forming headwinds that we, and a handful of others, offer a rebuttal. In fact, our friends at First Trust have done the detail work of compiling the evidence which more soberly informs us we’re facing a correction, not a recession. We gratefully reprise that analysis here.
It should be easy enough to test whether a recession is building simply by looking at the profits being reported by S&P 500 companies. If they’re shrinking, there’s evidence of recession. Well, as of this writing, 375 S&P companies have reported Q4 earnings. 352 of these companies are actually up 1% from a year ago, and 71% actually beat estimates. It is the remaining 23 companies, all from the energy sector, which account for the “downturn” in profits.

So, for those claiming the market drop is due to declining earnings, the evidence shows it’s an energy story, not one about the general economy. We readily admit that 1% growth is nothing to brag about, but growth, of any size, is distinctly different than contraction.

Corrections have a way of scaring people, and this one of those corrections. But it is an emotional correction, not a fundamental one.  The US is not entering a recession.  Consider a few more facts:

Retail sales rose 0.2% in January, beating consensus expectations and were up 0.4% including revisions to prior months.  This is the third consecutive month of gains, which is particularly impressive considering gas station sales plummeted 3.1% in January, due to lower prices at the pump. Again more of an energy story than an economic one.  Excluding gas stations, retail sales have risen seven months in a row and are up 4.5% from a year ago.

In 2015, hourly earnings rose 2.7%, accelerating from the -2.0% trend seen over the previous two years. At the same time, initial jobless claims have been below 300,000 for 49 consecutive weeks. Private payrolls grew at a 216,000 monthly rate in 2015, and the unemployment rate is down to 4.9%.

And no, this is not a “part-time” recovery. In the past twelve months, full-time employment has grown by 2.5 million jobs while part-time employment is down 120 thousand! With 5.6 million unfilled jobs (the second highest on record), and quit rates at the highest levels of the recovery, there should be little question why the Fed needed, and actually started, to hike rates in December.

Some have argued that we may also be nearing a deflationary spiral, the argument being that because oil has plummeted we must be near deflation if not already there. But, “core” inflation, which excludes the volatile food and energy components, was up 2.1% year-to-year in December, very close to the Fed’s 2% inflation target. Even with the huge drop in oil, the overall index is still up 0.7% in the past twelve months. In other words, we don’t have deflation in the US.

One way you can tell that a correction is largely emotional is when polar opposites are the supposed cause for things being “bad”. At one point, high oil prices were bad; now we hear that low oil prices are bad. At one point, the Fed raising interest rates was going to be bad; now we hear that if the Fed delays the next rate hike, that’s bad. When pundits scramble for blatantly contradictory reasons to support their opinion that things are “bad”, you know emotions, not logic, are ruling the day.

To put it succinctly, the fundamentals of the economy show no evidence of recession.  This is a correction, not a turning point for the stock market.  Our models, with stocks driven by interest rates and corporate profits, not emotion, suggest the market is still significantly undervalued.

It isn’t often you get recession level prices when there is no recession. The best advice we can give is to put money to work; don’t run away from this opportunity.