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2022 Investment Outlook: Recession Risk & Implications

By Richard "Crit" Thomas, CFA, CAIA
Economy & Markets
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2022 Investment Outlook: Recession Risk and Implications
Video Transcript

We believe a recession is likely, which raises the question of what kind of recession and how will the markets perform. This is what I want to briefly cover.

While recessions can be painful, they can also be healthy as we work off excesses built up over the previous cycle. Typically, those excesses are related to credit and leverage. But we haven’t built up much in the way of excesses. While there are certainly weak pockets, in general US consumers and businesses are financially strong.

So while the Fed is likely to push us into a recession, it is unlikely to spill out into something larger. The credit dominoes too widely spaced. It will still hurt in places, but we see a milder recession overall.

Unfortunately, that doesn’t necessarily suggest a mild bear market for equities. We believe earnings are going to get ratcheted down. The S&P 500 index just hit all-time high profit margins last quarter.

S&P 500 Index Profit Margin

Part of those high profit margins were due to the government giving everyone money, and then we spent it on goods, to which the S&P 500 is more biased, compositionally. Now the money running out and the Fed is going to compound that by pushing up interest rates and dampening demand even more. And while demand starts to slow, companies will still be faced with cost pressures – higher wages and input costs. We believe that profit margins will get squeezed and earnings are coming down.

Business Costs of Production

Now there is some good news here as the market is already down about 20%. We think there is further to go, but the worst of the decline may be already behind us.
 
The picture is much better when we turn to fixed income. Fixed income has sold off as well, raising interest rates making them more attractive. And as the economy slows, long term yields may begin to slip. And then when it comes to credit, while lower quality companies will be stressed, we don’t see default rates rising to the levels of past recessions. As mentioned, we just haven’t built up those credit excesses. Also for fixed high yield debt there is no big maturity wall in front of us, it’s more like a curb. So much less refinancing risk.

Time Left

This commentary is for informational purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security. There is no guarantee that the information is complete or timely. Past performance is no guarantee of future results. Investing in an index is not possible. Investing involves risk, including the possible loss of principal and fluctuation of value. Please visit touchstoneinvestments.com for performance information current to the most recent month-end.


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crit thomas global market strategist

Richard "Crit" Thomas, CFA, CAIA

Global Market Strategist
Crit is responsible for examining and evaluating economic conditions, generating insights and providing a sharpened perspective on investment strategies for enriched portfolio construction.