U.S. real gross domestic production growth rebounded to 2.6% in the third quarter of 2022.
Share prices lead production, not the other way around.
Investors shouldn’t be distracted by further potential economic challenges.
At first blush, it looks like the U.S. economy rebounded to a better-than-expected 2.6% pace of growth in the third quarter of 20221. In other words, the “technical recession” — consisting of two consecutive quarters of negative real gross domestic production (GDP) growth — appears to have ended in June.
Yes, the historical relationship between S&P 500 price returns (pushed forward by half a year) and real GDP growth suggests more economic and earnings challenges may lie ahead of us. In my view, however, investors shouldn’t let that distract them. While far from perfect, stocks are decent leading indicators of inflation-adjusted business activity, meaning the dark blue line (S&P 500) is suggesting where the light blue line (real GDP) is likely heading (Figure 1).
As the Great One, Wayne Gretzky, said “I skate to where the puck is going to be, not where it has been.”
Figure 1. It’s early, but nimble investors should prepare for a market recovery first and an economic recovery second.
Sources: Bloomberg L.P., FRED, Standard & Poor’s, Invesco, 11/3/22. Notes: NBER = National Bureau of Economic Research. Shaded areas denote NBER-defined U.S. recessions. An investment cannot be made in an index. Past performance does not guarantee future results. There is no guarantee that estimates or forecasts will come to pass.
True, U.S. stocks have witnessed declines — albeit relatively shallow ones — in the absence of economic recessions: 1994/95, 2012, and 2016 to name a few years.
However, it’s worth mentioning that U.S. stocks fell more this year (-17% year-over-year through September 2022) than they did near the 2020 recession, which seems consistent with the notion of at least a short business cycle contraction.
But the same delayed relationship between stocks and GDP also argues that a market rally in the present could be followed by an economic recovery about half a year in the future.
Admittedly, this market drawdown has felt like an “everything” bear market, especially for growthy U.S. technology stocks.
By contrast, I think that a blossoming recovery trade – including international, cyclical small-cap value stocks – has started to gain the support of four key developments:
I’m seeing signposts along the road to recovery and progress on my technical checklist of market bottom indicators. As such, I would caution longer-term investors against getting too much more bearish on stocks. From my lens, the discount rate for U.S. stocks has come down noticeably, helped by a welcome turn in the inflation cycle.
What does a U.S. stock market recovery depend on? It relies on five peaks, four of which are clearly visible, according to Equity Strategist Talley Léger.
The U.S. Federal Reserve has made progress in cooling down an overheated U.S. economy through restrictive financial conditions. Many investors may be inclined to sell stocks on bad economic news. However, history suggests that could be a regrettable course of action.
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Some references are U.S. centric and may not apply to Canada.
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Past performance does not guarantee future results. Investments cannot be made directly in an index.
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The opinions referenced above are those of the author as of Nov. 4, 2022. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
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