The initial estimate for second-quarter GDP by the Bureau of Economic Analysis came in Thursday at a decline of 0.9%, which follows a 1.6% contraction in the first quarter. Predictably, there was much handwringing about whether this means we are in a recession or whether it is just a technical transition to slower economic activity. I am not going to take sides here, but I am just going to be grateful we are not Europe where a full-blown recession seems unlikely to be avoided.
The markets have posted two solid days of advances despite the Fed's move to raise interest rates another 75 basis points Wednesday, which was expected. Investors hope this is the last of the big hikes and going forward the central bank will push interest rates up in increments of 25 or 50 basis points. Personally, I think we might be getting too complacent here.
It is true that second-quarter earnings reports have not been as bad as feared despite some notable misses from companies such as Walmart (WMT) , Snap Inc. (SNAP) and several well-known names. However, I don't think we are through the woods yet. The impact of higher interest rates is just starting to be felt throughout the economy. They already have produced a much softer housing market and higher rates will continue to curtail economic activity in many sectors.
So far, the job market has held up well and continues to show significant growth. It is important to note that we are still below pre-pandemic job levels and the return to normalcy has been the key engine behind these job gains. They will also be much harder to come by in the months ahead. Many companies adjusted to slowing growth by putting off planned hiring in the second quarter. Look for that to transition to workforce reductions in the quarters ahead.
With inflation still stubbornly high, the central bank has little choice but to continue to apply the brakes on the economy. Based on the recent rebound in stocks, many investors seem to be pricing in a much higher probability that Fed Chairman Jerome Powell can achieve a soft landing than I do. The Fed simply waited too long to deal with surging prices, and putting the inflation genie back in the bottle is not going to be pretty.
I would love to be proven wrong in my stance as my portfolio would be better off for it. With almost my entire holdings held within covered call positions, my portfolio will benefit nicely from a continuing rally or simply a flat market for that matter.
I am also at just under 25% in cash at the moment to be prepared to take advantage of the next leg down in the market. I think that moment could arrive when investors realize that the Fed needs to push the economy into a significant contraction to cool inflation.
