• Probability for a cyclical economic recession, with accompanying weakened demand, rising unemployment, and moderating inflation, still looks uncomfortably high.
  • While recessions often bring their own nasty surprises, current data is still consistent with the unfolding of a milder downturn. Growth is being supported by strong balance sheets, strong underlying structural trends, and the fact that the Fed is the catalyst for the economic slowdown, as opposed to a black swan event such as a pandemic or the collapse of the global banking system.
  • Phase one of the inflation slowdown—a sharp decline in the cyclical/transitory components—is now largely over, and we are transitioning to phase two, where the baton of disinflation is passed to the demand side of the economy. Recent inflation data suggests a potential fumble during the handover in the near term, before the Fed achieves its inflation target by year-end.
  • Expectations for 100 basis points of rate cuts in 2024 are consistent with a shift away from the Volcker phase of inflation fighting and toward the Greenspan opportunistic phase, where the Fed is likely to drag its heels in matching declines in inflation. Longer-term expectations for only 200 basis points of cuts are inconsistent with the prospect of recession, the Fed’s behavior during past easing cycles, and current estimates of the real neutral rate of inflation.
  • Greater uncertainty resides at the longer end of the yield curve, due to Treasury Secretary Yellen’s unwinding “Operation Twist” in 2024, increased supply issuance, and shifts in demand-side participation.
  • Despite some similar analogies with the Magnificent 7 or the internet bubble of the late 1990s, the equity risk premium suggests that investors are being far more cautious than was the case back then.
  • While economic weakness is expected, history shows that smaller-cap stock cycles often begin at the economic trough, and this time around valuations on both a relative and absolute basis are historically low, and investors are also already discounting a significant amount of bad news.

For more information on the research reports published by Richard de Chazal, please contact us  or your William Blair representative.