A “rolling recession” has turned into a “rolling expansion” that indicates stocks could be set to see a 2023 rally continue and broaden out beyond megacap tech shares in the second half of the year, according to a closely followed Wall Street economist.
“To assess whether we’re having a rolling expansion is as well as to look at those industries and sectors that have been depressed. They’re showing signs of recovering,” Ed Yardeni, president of Yardeni Research, said in a phone interview Friday afternoon.
Yardeni pointed to the housing sector. Last year’s rate shock — with the Federal Reserve embarking on a hiking cycle that lifted the fed-funds rate from near zero in March 2022 to 5% to 5.25% this spring — knocked single-family housing hard as mortgage rates soared.
But the sector has recovered smartly as homeowners have proven reluctant to sell, constraining supply. Pent-up demand has fueled strength in the sector — and for home builders — despite mortgage rates that have risen toward 7%.
From there, the expansion appears to be rolling toward the manufacturing sector, Yardeni said. Retailers appear to have made progress working off a glut of inventories that built up in late 2022 and early 2023 after over-ordering amid the earlier supply-chain disruptions. He expects coming purchasing managers index readings to soon begin showing signs of a bottom.
The sun won’t cast its rays on everything, however, Yardeni sees pain ahead for commercial real estate, but expects it to be confined largely to old office buildings.
“Malls, hotels and warehouses — those areas of the economy won’t be expanding in a major way, but they won’t be contracting either,” he said.
It’s a scenario in which the overall economy should be able to continue to moderate without falling into recession, Yardeni said. As defined by the National Bureau of Economic Research, a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months.
Investor expectations for a recession have waxed and waned in 2023. The collapse of Silicon Valley Bank and other regional lenders in March sparked fears of a credit crunch that would accelerate the economy’s fall into recession as lagging effects of the Federal Reserve’s breakneck series of rate increases that began in March 2022 hit the economy.
A labor market that’s shown some signs of cooling but remains hot by historical standards — and resilient consumer spending — is reducing fears of an imminent recession. Analysts say fading recession fears have helped the stock market continue a 2023 rally that saw the S&P 500
rise nearly 16% in the first half.
Consumers still have firepower, he said. Stronger interest income, while dividend income, rental income and proprietors income are all at record highs, he noted. “And on top of that, Social Security payments are at an all-time record high,” Yardeni noted.
Yardeni, meanwhile, had argued that the economy had suffered the aforementioned rolling recession, which he now sees giving way to the rolling expansion.
Worries the Fed will need to keep jacking up rates beyond what investors or policy makers currently expect. Most of the inflation story appears to have been driven by shock waves from the pandemic, he said, which means the Fed doesn’t need a recession to see inflation moderate. In fact, there may even be signs of “rolling disinflation,” he said, with goods inflation nearing zero, durable-goods inflation turning negative and nondurable food and energy prices falling significantly, while services inflation persists.
A rolling expansion should allow the stock market rally to broaden out in the second half of 2023. Gains have been concentrated in megacap tech stocks, with a “magnificent seven” coterie of shares accounting for nearly all the S&P 500’s gains.
Indeed, the average stock has lagged behind. An equalweight measure of the S&P 500, which as the name implies weighs each component equally instead of by market capitalization, was up just 6% in the first half. The more cyclically oriented Dow Jones Industrial Average
rose just 3.8%.
“Obviously, the leaders are becoming increasingly pricey,” Yardeni said.
But artificial intelligence is sparking a new industrial revolution that has yet to play out. Investors will get excited about companies that aren’t necessarily making technology but using it to become more productive, he said.