No two recessions are the same. But the potential recession in 2022 looks like the most unique we have ever seen.
Some traditional signs of an economic slowdown are already upon us. US GDP has shrunk for two quarters in a row – the textbook definition of a technical recession.
Meanwhile, homebuilding activity has slumped while consumer confidence is at its lowest point since the pandemic broke out. However, President Joe Biden said Thursday that the nation is still “on the right track.”
Here are three big reasons why the next recession is different.
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The labor market is robust
In most recessions, economic output and employment decline simultaneously. Lower incomes force companies to cut staff, leading to higher unemployment. Ultimately, higher unemployment leads to lower consumer spending and that creates a vicious cycle.
In 2022, however, unemployment is still at an all-time low. The official unemployment rate in June was 3.6%, the lowest since February 2020. A strong job market is “historically unusual” during a recession, according to Goldman Sachs economists.
This unusually strong job market could be drawing strength from another unusual source: corporate financial strength.
Companies are cash rich
Corporations see a decline in sales and profits during recessions. That process may have already begun. However, US corporations are holding onto their profits and have a huge cash cache going into this recession.
The average US corporation’s after-tax profit margin is around 16% right now. In traditional recessions, this rate drops to single digits. Meanwhile, these corporations collectively have more than $4 trillion in cash. That is a record level and also very unusual for a recessionary environment.
The companies may have raised these funds during the era of easy money and low interest rates over the last decade. Now, this cash is acting as a buffer and could allow companies to retain staff despite the economic slowdown. rates are going up
Another unusual factor in this recession is the aggressive stance of the Federal Reserve. In most recessions, the central bank lowers interest rates and adds more money to the economy to stabilize it.
However, in 2022, the Fed has been aggressively raising rates to curb inflation. Given the strength of the labor market and corporate balance sheets, the central bank may have more reason to keep raising rates.
What comes next?
“This is unsustainable,” says WSJ’s Jon Hilsenrath. He believes one of two things must happen to fix this mismatch: either the economy recovers quickly, ending the recession, or the economy continues to slide, forcing employers to cut jobs.
These two scenarios could potentially be the “soft landing” and the “hard landing” that the Fed has mentioned earlier. Investors need to keep an eye on all the indicators to see what scenario is unfolding because the impact could be severe.
This could be an ideal time to bet on beaten growth and tech stocks if a soft landing occurs. However, in the event of a hard landing, investors may need to take refuge in defensive asset-backed stocks such as health care companies and real estate mutual funds.
In any case, 2022 is shaping up to be an interesting year for investors.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.