What Does A Yellow Light Mean?

“What does a yellow light mean? Slow down! Okay. Whaat dooes. a yellllow liight mean?” That’s from our favourite episode of the sitcom Taxi when Jim was taking his driver’s test. It’s a classic. Here is the link to a brief clip if you haven’t seen it, or even if you have: https://www.youtube.com/watch?v=39k067hcgYY.

Global economies had been growing at an unsustainably high rate, and growth was bound to slow. Now, numerous factors are acting to slow GDP growth: less accommodation from central banks, including interest rate hikes leading to higher borrowing costs; removal of direct government stimulus cheques; deleterious impacts on Europe from Russia’s incursion, not to mention the mass exodus from Russia by western companies; Chinese lockdowns; a strong USD; and the impact of the inflationary spike on pocketbooks and profit margins.

Spotlight on Inflation

Most believe we are destined for a recession, if not already in one. Between the negative sentiment and the stock price valuation reset that needed to take place, it’s not surprising that the markets have meaningfully softened.

While the economy is clearly slowing, we do not foresee an imminent recession. Our Economic Composite (TECTM) has called every recession in advance since the '60s (based on backtesting and actual experience in 2020), without a false signal—each of the 9 times it alerted to a recession, one occurred shortly thereafter. Importantly, a recession has not occured without a preceding signal. And TECTM is not alerting us to one now in any major economy. In such a frenetic period TECTM may not detect a recession but if conditions deteriorate further, our multi-pronged risk-management approach, which also considers market momentum and valuation, should still allow us to act.

The consumer, who represents nearly 70% of economic activity, is in better shape than their sentiment would suggest. Unemployment is at lows; wages are rising; debt service ratios are low, and savings rates are relatively high.

In Q1, major supply chain adjustments in the U.S. caused exports to increase by only 6% while imports jumped 18%, and lower inventories also reduced GDP, producing a 1.4% contraction. If Q2 is similarly weak, we could see a technical recession (2 quarters of negative growth). But it would likely be shallow. “Sales to domestic purchasers” in Q1 increased by 2.7%, an indicator of continued consumer strength which, again, drives most of GDP.

With inflation dampening consumer confidence, consumer sentiment is already at levels normally associated with deep recessions. This should provide a natural softening of demand, which along with central bank dampening efforts (printing less money) should quell inflation (U.S. core PCE dipped recently to 5.2% after hitting a 40-year high). Repairing supply chain issues, which have been slow to dissipate, should ultimately help reduce price pressures too. We are already seeing signs of commodity price peaks, both for industrial commodities and food and energy related ones (isn’t it like the numbers at the gas pump are wrong?). Meanwhile, overall disinflationary pressures from poor demographics and high government debt which suppress growth, and the technological productivity revolution which keeps prices in check, haven’t dissipated.