Opinion: The U.S. isn’t headed for recession. Nor will it be consumed by inflationary fires.


“Some people say that the world will end in fire,” says a famous phrase from Robert Frost. “And some say on ice.”

If poetry could ever explain the stock market, this could be closer to capturing the sour mood that is about to produce a seventh consecutive week of stock market losses.

With half of the world’s investors seemingly frightened by rising prices and the other half worried about growth, there are very few buyers ready to balance the general sadness.

But while there is almost no hiding place when stagnation and inflation clash, this economic adjustment does not seem to be the start of a persistent illness. Rather, it has the elements of a temporary shock that will soon restore the economy to equilibrium.

This hardly relieves the pain of the last six months of SPX stock market,
-1.27%
it is declining, but it does not justify the serious warnings of an impending recession in the United States. The latest spikes in food and energy prices have already begun to hurt consumer sentiment, making the Fed’s task of stabilizing prices much easier to achieve. Growth is sure to slow down from here, but it’s hard to imagine a sharp collapse in demand as consumers and businesses have rarely been like that.

Disorienting

These are clearly disorienting times. After nearly four decades of declining inflation and mostly solid growth, few active investors have ever faced markets that feel the heat of such a sharp price rise. Aside from the 2008 financial crisis, which has been going on for 14 years, the trembling outlook for recession has been relatively short-lived.

Analysts who choose hypotheses for their valuation models have long faced this dilemma. Should they use the Fed’s 2% long-term inflation forecast when they know their car has just taken $ 60 in gas? Can the Fed really alleviate the growth of its projection from 2.0% to 2.9% for next year by executing what President Jerome Powell now calls a “soft landing.”

Shares have been falling because in this environment no one goes through an investment committee with sunny assumptions about inflation or growth. Meanwhile, the uncertainty surrounding the two sets of numbers makes it difficult to know what is cheap. When rates dropped reliably and earnings were predictable, it was easy to convince yourself of price multiples to earnings in the 1920s. Investors today are unsure if the stock will be offered now that the S&P 500 multiples are now in their teens.

But the case of America consumed by inflationary fires simply does not support scrutiny. First, U.S. consumer price inflation appears to have peaked last week, although wage pressures still need to be monitored. Second, if higher prices don’t force many summer travel cancellations, they will ease this year’s Christmas shopping frenzy, even if supply chains don’t return completely to normal. Third, and most importantly, long-term rates remain stable even as short-term rates rise, suggesting that markets believe the Fed will be able to stabilize prices.

It is technically possible for the United States to fall into a recession next year, but many more should go wrong. In the midst of the dark headlines, it’s easy to forget that unemployment has hit near-historic lows and workers have quit their jobs in search of something better near historic highs. Business capital spending has risen and companies are investing in more advanced technology and more resilient supply chains.

Lots of risks

It is difficult to predict how much damage will occur when the economy “shrinks.” If the Fed is to meet a mandate to offer “stable prices,” it will have to settle for a lower level for its other “maximum employment” mandate. Loan defaults will need to increase from their historically low levels. The housing market will have to stabilize.

Meanwhile, there are many risks beyond the U.S. coast that could weigh on the U.S. economy. Europeans are now facing dramatically higher energy prices as they tighten sanctions on Russia. Food-importing countries also face much higher prices for wheat and fertilizers. In China, COVID restrictions were undermined, as industrial production fell by a staggering 2.9% last month, threatening further disruptions to global supply chains.

Many of these risks have appeared suddenly and unexpectedly, creating strong headwinds for US stocks. The irony is that relatively strong price shocks from supply chain disruptions and commodity price spikes make hot demand more likely to cool on its own. Inflation rates may find a new range above pre-pandemic levels, but they will be lower and more predictable than they are today.

There may be more fire and more ice. But the world will not end.

Christopher Smart is the global chief strategist at the Barings Investment Institute. Follow him on Twitter @csmart.

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