With lingering concerns over COVID, the spike in inflation, and fighting in Ukraine, this hasn’t been to most pleasant economic expansion we’ve experienced. Now, as consumer sentiment begins to slip amid higher interest rates and food and energy prices, there’s more talk about the possibility of a recession.
However, I don’t think I’m being at all contrarian when I suggest we shouldn’t be losing ourselves in this spate of bad news. After all, the U.S. economy is still growing, and the job market is going strong with no apparent signs of any recessionary trouble. Of course, that all could change in the near future, and I think the Fed will have some say in how this plays out over the next six to nine months. But, for now, I don’t think there’s reason to worry.
Let’s explore this a little further.
Inflation’s Effect on Consumer Spending
No one is immune from the effects of higher energy and food prices. It’s like an immediate tax on consumers, so it obviously impacts sentiment. People are forced to spend less on certain things so they can afford to fill up their gas tanks. But that doesn’t necessarily hurt the economy. It’s simply money being diverted from one sector (i.e., retail) to another (energy).
With the price of oil over a hundred dollars a barrel, the oil and gas sector is going to generate record profits for the first time in years. And, because the U.S. produces 95% of its own energy, those profits are going to U.S. companies. So, while consumer spending may be slowing in retail sales, it’s being offset in the economy by increasing energy sales and profits. It may not be the ideal way to get money into the economy, but at least it will help prevent a recession.
The bottom line is that, while it’s estimated that U.S. consumption is going to take a $200 billion hit from higher energy prices, it is offset to a great extent by an estimated $2 trillion socked away in U.S. household savings. Between that and a tight labor market fueling the consumption machine, any talk of a recession would be premature.
What about the Labor Market?
Lost among the warnings of a recession is the fact that the country is experiencing record-low unemployment. That means anyone who wants a job can get one. Employers can’t hire enough people, so they’re raising their pay scales and lavishing benefits on their employees.
The upside is even greater considering the low job participation rate, meaning there are far more jobs than people willing to take them. Though many of those people who were downsized due to the pandemic have decided not to get back into the workforce, choosing to retire early or join the gig economy. That will be a significant challenge for policymakers working to shore up labor shortages that are driving up labor costs. In turn, wages are rising as an incentive to draw in more workers. So now workers not only have a broader choice in job opportunities, but they can also expect to make more.
The bottom line, for now, is consumers are benefiting from a tight labor market that’s still driving the consumption fuel they need to spend money.
Where’s the Tipping Point?
Right now, we’re in a sweet spot as a country because the economy is running well, which makes it possible to handle this level of inflation. It may be uncomfortable, but we can handle it. However, the economy could start to waver if inflation runs too hot for too long and starts to outpace earnings power. That could create a situation where consumers must begin making difficult decisions. Instead of reallocating their spending from entertainment to gas, they decide they need to cut back across the board.
Consumer spending makes up 70% of the economy. When that drops significantly, it affects every other aspect of the economy with the potential to lead to a recession. But it appears we are a ways off from that happening.
What’s the Investment Perspective on all of This?
While there are reasons to be confident about the economy in the foreseeable future, the unsettling geopolitical and inflationary environment should translate to a bumpy ride in the stock market. Investors can expect more volatility, especially as world events and the Fed’s monetary policy continue to unfold. And you can expect the financial media to continue their fear campaign on impending doom with predictions of a recession just around the corner.
Eventually, they’ll be right—even a broken clock is right twice a day. The hardest thing to do in these environments is to keep things in perspective, but it’s the best way to get through it. As a long-term investor, you don’t invest for tomorrow or even next year. You’re investing for a whole market cycle, which will take you through recessions, corrections, and maybe a crash. But it will also take you to new market highs along the way. With that perspective, you don’t need to fear recessions.
Wealth can never be built by trying to time the market or economic cycle—it just can’t be done. Wealth is built based on time in the market. If you invest in great businesses, they will make it through recessions and market turmoil. Great companies know how to advance through the worst of conditions—continuing to expand, develop new products, and hire talented people. It may not show in their stock prices when the economy or the market is down, but they are the companies that lead the recovery. When you invest in well-managed companies with strong brands and market positions, there’s no need to try to time the market or worry about the next recession.
