By Michael Brush
A so-called hard landing of the U.S. economy is not going to happen. It’s a false fear. We may have a bumpy landing, but the odds of hard landing — a possible recession — are low for the reasons below.
If I am right, it confirms what extremely negative sentiment is already telling us: Stocks are a buy.
I also suggest several stocks, below, that artificial intelligence tells us may be among the best performers, as investors figure out recession risk is low.
1. The economy is strong
That 1.4% first-quarter GDP contraction is pretty misleading. It was caused by a drop in federal spending and a big increase in the trade deficit. Two more meaningful measures show decent economic strength, says Ed Yardeni of Yardeni Research. He cites the 3.7% increase in final sales to private domestic buyers. Real personal consumption spending also rose to a record.
We see signs of global strength, too. Excluding China, global services and industry purchasing managers indices came in at around 55 for April. Below 50 signals economic weakness, so this is a decent reading.
“The global economy is weathering the near-term headwinds relatively well,” say economists at JPMorgan. They expect 2% global GDP growth in the second quarter.
2. The yield curve is not predicting a recession
The yield curve is the gap between various short-term and long-term interest rates in the bond market. This trusty recession forecaster is pretty darn good. Right now, the yield curve is sloping upward. This means it isn’t predicting a recession. “We expect that the Fed may well be able to avoid a hard landing,” says John Stoltzfus, the chief investment strategist at Oppenheimer Asset Management “That said, a bumpy landing is not out of the question.”
3. Companies are guiding up, not down
Companies are the economy. Top managers continue to expect growth. We know this because they are guiding future earnings higher. Second-quarter earnings guidance is slightly above the long-term trend, says Credit Suisse.
4. The household sector is strong
Typically, economies are vulnerable to recessions when households borrow too much money, then get into trouble because they cannot pay it back. That’s not the case now.
People socked away a lot of money during the pandemic. So, households had a surplus worth 3.6% of GDP in late 2021, compared to an average of 2.8% over 1985-2019, note Goldman Sachs economists. “The household sector is on particularly strong footing,” says Goldman economist Jan Hatzius. “Soft landings are more common when private sector financial balances are healthy.”
5. Companies are cash-rich
Cash holdings increased substantially during the pandemic at businesses small and large. Importantly, this also happened at riskier junk bond issuers. These are the ones that blow up when interest rates rise, causing recessions by spreading damage to business partners and banks. “Refinancing risk and vulnerability to higher interest rates is low because most high-yield issuers already refinanced at favorable rates,” says Hatzius. Corporate profit margins also remain close to record-high levels.
“The conditions likely to undermine the expansion are not yet established,” agree economists at JPMorgan. “The private sector is in remarkably good health. Balance sheets are flush with cash.”
6. Junk bond credit spreads are narrowing
The spread between yields on riskier, high-yield “junk bonds” and safer U.S. government bonds can be a good recession indicator. When it widens, it tells us bond investors are running away from riskier companies because they see a recession coming. Right now, this spread is narrowing, points out Martin Pring in his InterMarket Review investment letter. “Investors are willing to take risks in order to earn a higher yield,” says Pring. “In other words, they are downplaying the prospects of a recession.”
7. Signs confirm inflation has peaked
In addition to the signals I mentioned in this column , core CPI for March came in below expectations when it was reported in late April. This was the first below-consensus reading since August. “We believe the peak for core inflation is now behind us,” says Hatzius at Goldman Sachs. “The surge in goods inflation caused by shortages and rising commodity prices has likely peaked and should moderate by year-end.”
Goldman forecasts inflation back in the 2% range as soon as next year. Hatzius expects 2.4% at the end of 2023. That may seem like a long way off. But remember that the stock market prices trends about six months in advance. And signs of progress along the way will calm stock investors. We get important April consumer and producer price inflation reads this week — May 11 and 12.
8. Company insiders see no recession ahead
Corporate insiders are not dumping stock in excessive amounts relative to their buying. They are telling us that no recession is on the way. Short-term sell-buy ratios for insiders at New York Stock Exchange (NYSE) companies actually turned bullish recently, according to Vickers Insider Weekly. Longer-term NYSE measures are neutral. So are the insider sell-buy ratios for Nasdaq. I’d rather see insiders bullish across the board, but they certainly aren’t cautious.
Stocks to consider
Given that the wild volatility has made a lot of people emotional, I think it makes sense to turn to the “machines” for stock ideas, meaning algos that use artificial intelligence (AI) to spot buyable stocks.
So, I recently caught up with Jan Szilagyi, the CEO of Toggle. Its system uses AI to pick the stocks based on quantitative analysis and machine learning. Toggle has about a hundred institutional clients with $185 billion under management, as well as 70,000 retail investors, says Szilagyi, a former quant trader at Stan Druckenmiller’s Duquesne Capital.
“The system looks for assets that look so stretched, so cheap or expensive, that the odds are skewed in favor of a move in one direction,” he says.
Toggle analyzes dozens of data points — from valuations and analyst expectations, to fundamentals and technical factors like price momentum and relative strength.
The group with the most stretched valuations to the downside at the moment? Homebuilders and related retailers. He cites Lennar (NYS:LEN) , PulteGroup (NYS:PHM) , Toll Brothers (NYS:TOL) , Home Depot (NYS:HD) and Lowe’s (NYS:LOW) . “All five, from the system’s point of view, look skewed to move higher,” he says.
They are beaten down because rising mortgage rates have reduced housing affordability. But investors are also dumping them because of recession fears. In recessions, people lose jobs and incomes, which makes them less likely to qualify for mortgages, or even want to.
So, if I am right and there is no recession, homebuilders will benefit nicely as this risk gets taken off the table. “The system’s working assumption is no recession,” says Szilagyi.
Since value investors are quants at their core, it’s interesting to see that value investor Bruce Kaser of the Cabot Turnaround Letter singled out the homebuilder M/I Homes (NYS:MHO) on May 6 as a featured suggestion. “Its share valuation implies a dismal future, which seems unlikely to arrive anytime soon,” says Kaser.
Toggle also singles out stocks in other highly cyclical areas. This makes sense. Cyclical stocks get beaten down badly by recession fears. Toggle points to these names in cyclical financial services, logistics, industry and banking: Ameriprise Financial (NYS:AMP) , FedEx (NYS:FDX) , United Parcel Service (NYS:UPS) , Stanley Black & Decker (NYS:SWK) and the two small-cap banks Franklin Financial Services (NAS:FRAF) and Home Bancorp (NAS:HBCP) .
Finally, crypto fans should rejoice. The Toggle system also favors Grayscale Digital Large Cap Fund (OTC:GDLC) , an investment vehicle that offers a diversified basket of digital currencies. It currently trades at or near its 52-week low.
Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested TOL, HD, LOW, FDX and FRAF in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.