Here’s why investors fear a US recession, and whether the fears are justified

Investors fear a US recession – there’s no denying it and there’s no other explanation for the market correction in the last week. But are these fears justified?

Why investors fear a US recession

Because there are data points that are showing markets could be headed that way. There was a very fine tightrope central banks were seeking to walk, hiking interest rates enough to slow economic activity and inflation, but not so much as to send the economy into recession. For most of the past few months, investors had thought a so-called ‘soft landing‘ was happening and a ‘hard landing’, where interest rate hikes slowed activity too much, would be avoided. But it seems the ‘soft landing’ might just be the beginning of a ‘hard landing’.

Specifically in the last week, US jobless figures showed a surprising number of Americans out of work. Unemployment was 4.3%, the highest since 2021, and non-farm payrolls grew by just 114,000 last month, a slowing from 179,000 in June and below the 185,000 economists had expected.

Another troubling piece of data was that US manufacturing had dropped to an eight-month low. Specifically, the PMI of the Institute of Supply Management (ISM) showed 46.8, down from 48.5 a month ago. For reference, anything below 50 indicates a contraction in the manufacturing sector.

Disappointing results from tech firms, including Amazon, Alphabet and Intel, did not help matters. Investors fear tech companies have hyped and invested too much in AI, believing it was going to be as revolutionary as the Internet, but all investors can see is are consumer products like ChatGPT that may be useful, but are hardly ‘game changing’. News that Warren Buffett sold over $100bn in stocks in the June quarter did not help matters.

To the guy who spent his 700k inheritance on Intel: this is bullish.
byu/sco-go inwallstreetbets

It has been a bad week for investors

All the major US indices have dropped. The NASDAQ dipped 3.8% last week, while the S&P 500 and the Dow both shed over 2%. The ASX 200 has dipped nearly 5% in less than 2 trading days, right after hitting a fresh all-time high. It is the worst two-day sell-off in two years.

ASX 200 chart, log scale (Source: TradingView)

Two years ago, inflation was at its peak, and investors feared it wouldn’t get under control. Well now it is under control, but now it is seemingly time for the Fed to change course. And Jerome Powell admitted as such, hinting the first rate cut could come at its next meeting in mid-September. Other jurisdictions such as the UK and Canada have already commenced their rate reduction cycles. Unfortunately, just as our RBA was a laggard as other banks begun increasing interest rates, so it seems it will be during the forthcoming rate reduction cycle. Economists here are split as to whether it will be in November or February, but it is certainly not coming at its meeting this week.

So how should ASX investors prepare for a recession?

We’ve written about this more comprehensively here. To briefly summarise, investors should diversify into asset classes that may not be as volatile, like real estate. The trade-off is that they may not be as liquid, but then again it once was said that investing should be like watching grass grow or paint dry. The money that should be kept in stocks should be put into sectors traditionally more resilient during downturns, such as utilities, healthcare, and consumer staples.

Investors here are lucky with reporting season coming up over the next few weeks, and they will get to see just how their companies are going. Even certain companies you don’t own may be worth watching, perhaps competitors of your company, or suppliers.

It is important to stress that even if a US recession does happen, that does not necessarily mean it will here even if there is some impact to our economy, let alone to our stock market. And of course, as sad as it is for mortgage holders, don’t expect our RBA to cut rates just because the Fed did so.

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