Dougherty Dispatch—Is it a Recession or Not?

Dear (Confused?) Client:

So much to say, so difficult to figure out. This week has been a big week in economic and
financial reporting. Big companies have been reporting recent profits; the Federal Reserve has
announced a 0.75% hike in their interest rate to fight inflation; the government reported how
much our economy grew or didn’t (it shrank a hair). What does it all mean for our investment

Consider these reports:

1. High energy costs and supply problems have reduced the ability to buy other things.
Walmart reported disappointed results this week, saying its customers spent so much on
rising food costs, they didn’t have anything left to buy durable items on the other side of
the store.

2. Energy costs are coming down but will still be high given world turmoil and the desire to
transition to green.

3. Our job participation rate—that is, work-age adults working—has shrunk during covid
and has not recovered, due to retirements, under-qualified labor, and the inclination not
to work. However, an economy needs sufficient workers to grow. Reports from our own
clients taking road trips through the U.S. report to us that shortages of workers at
restaurants and hotels make traveling a mess. They wait in line to be seated at a
restaurant even though several tables are empty. There’s no one available to serve the
food and perhaps not enough cooks to prepare it.
And have you tried to travel by plane lately? Staff shortages have made flight
cancellations almost the routine.

4. The U.S. currently has 11.5 million unfilled job vacancies. Contrast this huge number
with the same period in 2019 (pre-Covid) when we had only 7.2 million unfilled jobs. If
we already have a historically low unemployment rate of 3.6%, where are we going to
get the people to fill these jobs--to work in the restaurants and design the new iPhones?
If we can’t find the workers, low growth will persist—and so too will supply chain

5. Even though the Federal Reserve has been raising rates, and mortgage rates have
increased dramatically—another slow down to the economy—other interest rates seem
to have already peaked and are starting to decline. A commonly used interest rate
benchmark, the 10- year treasury bond rate, has gone from 1.7% March 1st, up to 3.5%
June 14th, but now has gone back down to 2.7% today, even after the Fed raised its
short-term rate yesterday. Corporate bond rates also seem to have peaked a few weeks

Now Some Additional Perspective

Historically, economists say that if we have two straight quarters of the year with negative
economic growth, it signifies a “recession.” Growth for the first quarter of the year was an
annualized -1.9%, and for the most recent quarter -0.9%, thus two negative quarters. In other
words, a recession in conventional terms.

Ironically, the negative growth may be more caused by inflation and small work force rather than
how it traditionally works: Negative growth happens because the Fed raises rates.

Initially, this contraction is somewhat surprising because we earlier believed that we would get
positive results from the re-opening effects after covid and a positive bump from getting supplychain
issues resolved. But, really, if we are fighting high costs of goods and services, and have
millions of unfilled jobs, how can we realistically expect growth in the country?

And why is growth so important in the economy?
1. We have a growing population to support.
2. We have growing government to support.
3. Without growth, our standard of living declines.
4. If we miss growth in early years, our standard of living in future years is permanently

Stock and Bond Prices

Stagnant growth portends to be long-term. However, stock prices can still rebound. They
always have.

In an earlier dispatch, we indicated that the time to bargain hunt for stocks is when things look
the darkest and the Federal Reserve has indicated it will stop raising interest rates. As of today,
the stagnancy of the economy is official. But this hasn’t stopped the Fed from raising rates in
their primary quest during this period to fight inflation.

The chairman of the Federal Reserve indicated yesterday that his board intends to keep raising
the short-term interest rate to about 3.5% by the end of year. With the hike yesterday, it now
sits at 2.5%, so conceivably, he could raise rates by another 1% during 2022. This would cause
more slowdown in the economy and more stress on financial markets.

But, and here is the tricky thing: Because the Fed has actually announced this plan, the
markets know it now and theoretically have “priced” it into current stock and bond price levels.
Because most people who want a job can find one, they have money to spend—even for
restaurants, cars, and cruises. This has allowed many corporations to report positive financial
results recently—and has helped buoy stock prices. However, this economic spending may
keep price pressures high enough to keep the Fed fighting inflation with higher rates.

For clients with some funds on the sideline waiting to purchase stock type securities, it may be
time to put some of these funds back to work. The balance of the funds may remain on the
sidelines until the Federal Reserve indicates it plans to stop raising interest rates. This follows
the Wall Street dictum: Don’t invest new money while the Fed is trying to stifle the economy.
Or, more succinctly: Don’t fight the Fed.

Another Wall Street dictum: if you already have money in the market, don’t sell on a dip
because it’ll come back.

Sector Analysis

A view of what experts see for different sectors of the economy over the next year:

Travel: Good. Those working will have expendable funds for leisure travel, even though this
sector has been repeatedly hit by headwinds: Covid, high fuel costs, inflation, labor shortages.

Financials: Mediocre. Competition and more troubled consumer debt may cause some stress.

Energy: World stress from Russia war may have passed its peak and energy prices will drop,
reducing profits in this sector. There is a long term glut of fossil fuels. Up 31% for the year, but
down 19% in last 2 months.

Consumer Companies: Mediocre. Inflation and low growth hurt low income consumers who are
the backbone of growth in this sector.

Technology: After a big dip in tech stocks this year, their long-term growth structure promises a
price recovery in their stocks. This sector has recovered 15% in the last several weeks, but is
still down 21% for the year.

Healthcare: Steady growth with periodic ups and downs. Demographically a growth sector.

Commodities/Materials: Supply chain bottlenecks drove prices way up earlier and have
probably peaked and continue on their way down.

Real Estate: Slowing. It appears we just passed the peak of real estate prices, now lower with
mortgage rates that have almost doubled in the last 6 months. As overbuilding occurred during
this peak, expect it to be a buyer’s market again.

Here’s hoping your own household economy is not in a recession.

John D.