Making the case for mild recession and stock rebound in the second half

Don’t let the bear market in stocks, inflation at a 40-year high and the virtual certainty of a U.S. recession get you down, because the outlook might be less gloomy than you think.

A Wednesday morning webcast hosted by Columbia Threadneedle Investments made the case for much of the carnage already being behind U.S. markets and the economy, even though it will take several months to get back to rising stock prices and lower inflation levels.

William Davies, Columbia Threadneedle’s global chief investment officer, said he wouldn’t be surprised to see the Federal Reserve push the fed funds rate to around 3% by the end of the year. But he believes the rate is “less likely to get to 4%, as has been expected.”

The reason for the relative optimism, especially against the backdrop of the 8.6% inflation the Fed is trying to combat, is that the U.S. economy might already be in a recession. If it turns out to be a mild recession, Davies believes the Fed could tiptoe around a more aggressive rate hike cycle.

While Davies is still watching inflationary pressures, including pushes by organized labor for higher wages, he believes the Fed can be less aggressive with rate hikes, which could prevent the U.S. from entering a deep and prolonged recession.

A recession is defined as two consecutive quarters of negative economic growth. The U.S. economy experienced negative growth in the first quarter, and Davies believes it’s possible the second quarter will turn out to be negative as well.

“The U.S. may already be in recession,” he said. “Downward revisions to consumption could mean negative growth in second quarter. However, we do not believe that it will be a deep recession.”

Davies also expects inflation to start coming down toward the end of the year.

Connecting that outlook to the equity markets, Joshua Kutin, Columbia Threadneedle’s North America head of asset allocation, said the markets are already pricing in a mild recession, which makes a case for equities now.

“We generally continue to be tilting toward risky assets, with an equity overweight,” he said.

Davies echoed the sentiment of being bullish on stocks even after the worst first half for stocks in more than 50 years.

“We expect yields to stabilize,” he said, adding that removing the “worst fears about how high rates will go should give support to quality stocks more generally.”

However, Davies added, the backdrop of 2022 so far will pose a challenge for public companies as they report earnings the rest of the year. “This coming earnings season will be interesting, because I would suspect they will be reluctant to give forward-looking statements.”

Asked how they expect the stock market to respond over the rest of the year, both Davies and Kutin said a broad market index like the S&P 500 could be positive during the second half, but not enough to recover the full 19% loss since the start of the year.

“If we get stabilization of discount rates, I believe we will see profit expectations come down,” which would drive stocks higher, Davies said. “But it would be far too heroic to get positive for the year.”