When the Federal Reserve embarks on a hiking cycle, Piper Sandler's Michael Kantrowitz uses a four-step framework to assess how the U.S. economy is performing. He calls it HOPE, an acronym for "housing," "orders," "benefits" and "employment."
His theory when developing the framework five years ago was that housing is the first sector to feel the negative effects of higher rates, followed by new manufacturing orders, then corporate profits and, finally, the labor market.
So far in the current rally cycle, things are happening as Kantrowitz expects. Housing remains weak, as evidenced by low builder confidence and low sales volume. The manufacturing sector is contraction territory, according to the Institute for Supply Management's Purchasing Managers Index. And corporate profit growth has slowed significantly.
The only shoe left to drop is employment. And Kantrowitz, who Institutional investor survey Named one of Wall Street's top three stock strategists in October 2022, he sees signs that the labor market will indeed weaken, even as some on Wall Street begin to backtrack on their recession forecasts.
In a recent note to clients, Kantrowitz described the evidence he is seeing that indicates a recession is coming. One piece of data is the year-over-year percentage change of unemployed people. Kantrowitz's rule of thumb for determining whether the U.S. economy is in recession is whether the share of unemployed has increased by at least 10%. Right now, it's up 7.7% year over year and continuing to rise, prompting Kantrowitz to say it's a "big red flag for me."
Piper Sandler
"This is our preferred 'rule' for quantifying the start of a recession: when the percentage change in unemployed people exceeds the 10% barrier, we have always had a recession. This is similar to Ms. Sahm's rule, but avoids the potential volatility of the participation rate," Kantrowitz said, referring to the Sahm rule, which states that a 0.5% increase in the unemployment rate on a three-month moving average means a recession is beginning. It is named after Claudia Sahm, the Federal Reserve economist who devised the rule.
Still, although the unemployment rate has risen to 3.9% from its low of 3.4% earlier this year, jobless claims have not increased significantly. Kantrowitz thinks so, however, citing the relationship between homebuilder sentiment and increased claims.
Piper Sandler
"On employment, I see enough data to convince me that we are at the beginning of a recession right now," Kantrowitz said.
While Kantrowitz did not address his outlook for the S&P 500 in this particular client note, his target price range for the S&P 500 is 3,600-3,800. With the index hovering around 4,500, a drop to 3,600 would be a 20% drop.
A crucial stretch for the economy
Data in the coming months will continue to tell the story of how the US economy is weathering the most aggressive Fed rate hike cycle in four decades.
If the unemployment rate continues to rise, even slightly, the Sahm rule mentioned above will likely be triggered. And there is reason to believe that the labor market will weaken further.
In a recent note, Jon Wolfenbarger, founder of the investment newsletter BullAndBearProfits.com, noted that small businesses are cutting back on their hiring plans, according to the National Independent Business Administration. This usually means an increase in unemployment.
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Wolfenbarger also mentioned that the new steepening of the Treasury yield curve after periods of inversion often coincides with a weakening of the labor market.
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Earlier this month, the October nonfarm payrolls report showed that job growth continues to weaken. The U.S. economy added 150,000 jobs, below economists' expectations of 180,000. It was the second-lowest month of job growth since December 2020. Figures for September and August were also revised downward.
Other leading recession indicators also point to a slowdown, such as the Treasury yield curve and the Conference Board's leading economic index.
Many market observers see a recession in 2024including DoubleLine Capital CEO Jeffery Gundlach and Citadel founder Ken Griffin.
But many also continue to see a soft landing ahead. Jan Hatzius, chief economist at Goldman Sachs in the United States He said in recent notes that the rest of the Fed's fight against inflation will not be difficult and that the chances of a recession in the next year are only 15%. Brian Moynihan, CEO of Bank of America He also recently said he likes the prospects for the U.S. economy in 2024, thanks to a still-strong consumer.
