Investors are increasingly confident that the U.S. economy will achieve a “soft landing,” a scenario in which higher interest rates lead to lower inflation without significantly hurting economic growth.
On the surface, all signs seem to point to that outcome. Inflation has eased. The economy is still expanding. Consumer confidence has increased. Retail sales are strong. Corporate profits continue to be strong. And as stocks continue to hover at record highs, the Federal Reserve is set to cut interest rates before its next meeting on September 18th.
But one strategist warned on Yahoo Finance’s “Stocks in Translation” podcast that cracks are forming beneath the surface.
“We’re skating on a little thinner ice than a lot of people realize,” said Michael Dalda, chief economist and macro strategist at Roth Capital Partners.
Darda pointed to rising unemployment and rising earnings expectations, both of which contributed to the stock market crash seen in August and early September.
“It’s not unprecedented for there to be a period of economic slowdown that looks like a soft landing, and then a recession eventually materializes,” he said. “This is in some ways unexpected now, as many people have been fooled into thinking that a soft landing in the business cycle will be a permanent state. It reflects.”
“However, there are some cracks in the business cycle,” he warned, noting that expectations for the economy, businesses and stock markets remained at “super high” levels.
At that point, the S&P 500 on Tuesday was down 2%, dragged down by the tech sector after Nvidia (NVDA) gains didn’t provide enough momentum to satisfy investor appetite. In the days that followed, stocks tumbled wildly as the market struggled to find its footing following the sell-off.
“What’s unfolding now makes a lot of sense to me,” Dalda said of the exit. “We’re seeing companies that have been growing rapidly, with repeated strong performance in either sales or earnings, not performing as well in this recent period.”
Dalda said the recent drawdown shows how the current market – where investors are constantly chasing hot stocks and hot areas such as artificial intelligence – can be a “dangerous” game. That’s what it means.
“What this tells us is that expectations are very high. You can’t beat expectations forever. Eventually you will catch up,” he said. “We’re in a bit of a frenzy here. And if something starts to go wrong, whether earnings don’t meet expectations or the business cycle stalls, that’s when the stock market becomes potentially material. We’re going to see a reversal.”
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“Rippled sea”
But it wasn’t just the income. The job market also tells a special story.
July employment statistics released last month surprised the market by unexpectedly increasing the unemployment rate to 4.3%, the highest level in nearly three years. The rise also led to close monitoring of the recession indicator known as the SAHM rule.
This rule has been 100% accurate in predicting recessions since the early 1970s and measures the three-month average of the national unemployment rate compared to the lowest value over the previous 12 months. It is triggered when the unemployment rate rises by 0.5% above that level.
One strategist says cracks are starting to appear in the market and the U.S. economy. (Getty Images) (caitlin_w via Getty Images)
Traders immediately panicked as the economy slowed more than expected. But then a debate arose as to why the unemployment rate suddenly increased.
Economists and strategists have begun to offer possible scenarios, including the theory that above-trend immigration is pushing up labor force participation rates, squeezing unemployment by bringing more workers into the job market. This eased investor fears as stocks rebounded and ended August with wins for all three major indexes.
But Mr Dalda said the rise in unemployment remained “slightly concerning”. I’m also not entirely sold on recent bullish comments about rising unemployment being less of a problem as long as the economy continues to grow.
“4.3% remains an incredibly low level of unemployment and looks very good in historical context,” he said. “The problem is that we’re at 4.3% from the cyclical low of 3.4%.”
“These movements and levels indicate that, if the economy is still growing, it is growing below trend or below its potential,” he said. “There’s a very fine line between that and an actual recession.”
Investors digested another update on the job market on Friday, with the August non-farm employment report showing the unemployment rate fell slightly to 4.2%.
The market pared early losses following the announcement, but history suggests that stocks will continue to be volatile in the coming weeks and months.
“I think we’re probably in an environment of high volatility right now,” Darda surmised. “The risk of further significant withdrawals or adjustments is very high.”
Ultimately, his view is a cautious one: “What I’ve seen over the last two years in this market context, these valuation levels, and where I think we are in the economic cycle. Based on what you think, I think we’ll be “for a little while in the choppy ocean.” ”
Alexandra Canal is a senior reporter at Yahoo Finance. Follow her on X @allie_canalEmail LinkedIn, alexandra.canal@yahoofinance.com.
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