The U.S. economy is on relatively solid footing in the second half of 2024. But while inflation has cooled, progress has been choppy and inconsistent. Labor markets have remained stable, but the Federal Reserve has been cautious about pivoting to interest rate cuts.
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Many economists, including Federal Open Market Committee (FOMC) members, anticipate a soft landing for the U.S. economy in 2024 that includes slowing GDP growth but no recession. However, global markets were roiled in early August as a weaker-than-expected U.S. jobs report — which saw the unemployment rate tick upward to 4.3% — stoked fears of an economic downturn. Investors sold off stocks and other risky assets while fleeing to the safety of government bonds, and many analysts expressed concerns that the Fed has waited too long to cut interest rates. The three major U.S. stock indexes — the New York Stock Exchange, the Nasdaq and the Dow Jones Industrial Average — had each shed about 2.5% and more as of late-day on Aug. 5.
A single misstep in Fed policy could easily slow the economy so much that it contracts into a recession, making the next several months a critical period for the central bank. Investors fully expect the Fed to cut rates in September, perhaps by half a percentage point, and it could even opt for an emergency rate cut before then.
Economic recessions are no reason for panic and have been a regular occurrence over the past century. However, investors can make the most of a difficult situation by knowing which risk factors to watch and how to position their portfolios to optimize their performance if a recession is looming in 2024 or 2025.
2024 Recession Risk Factors
There are many factors that can trigger or contribute to a recession, but two specific factors are likely the biggest risks to economic stability in 2024:
Inflation
Any investor who hasn’t been living under a rock for the past two years is already aware that the primary economic risk factor in 2024 is inflation. After reaching a 40-year high of 9.1% in June 2022, year-over-year consumer price index inflation has fallen to just 3% as of June 2024.
The Federal Reserve can celebrate the progress it has made in 2024, but the latest core personal consumption expenditures (PCE) price index reading in late July suggests it’s too early to declare victory over inflation just yet. Core PCE, which excludes volatile food and energy prices and is the Fed’s preferred inflation measure, was up 2.6% year over year in June, above the Federal Reserve’s 2% target.
High Interest Rates
The second economic risk factor in 2024 is elevated interest rates. The Federal Reserve has taken an aggressive approach to combating inflation by raising interest rates to 23-year highs, and it has made significant progress in bringing inflation down. The FOMC has raised interest rates 11 times since March 2022, bringing its fed funds target rate range to between 5.25% and 5.5%. The Fed issued its most recent rate hike in July 2023.
Higher interest rates increase the cost of borrowing money, discouraging companies from taking on debt to invest in expansion. Higher rates also reduce consumer spending, easing demand pressures that contribute to rising prices.
The bond market is pricing in a 95% chance that rates will fall by at least a full percentage point by the end of the year, potentially stimulating the economy. The FOMC recently guided for only a single rate cut in 2024, but that projection was made well before the July jobs report.
To make matters worse, the last leg of the inflation battle may be the most difficult period for the Fed thanks to so-called sticky inflation. Sticky inflation is inflation in goods and services that have prices that are not very responsive to monetary policy adjustments, such as children’s clothing, auto insurance and medical products. Even as inflation in other areas of the economy continues to fall, sticky inflation may keep the Fed from reaching its inflation target for far longer than investors had hoped and force the central bank to further delay its pivot to rate cuts.
Will There Be a Recession in 2024?
Fortunately, inflation and rising rates have not yet dragged down the U.S. economy, but there are warning signs that it could start slowing in the second half of the year. The U.S. economy added only 114,000 jobs in July, and the U.S. unemployment rate also ticked higher to 4.3%.
Investors should continue to monitor the labor market and other economic data in the coming months as tight monetary policy often has a lagging impact on growth. U.S. GDP growth slowed from 3.4% in the fourth quarter of 2023 to just 1.4% in the first quarter of 2024, but it bounced back to 2.8% in the second quarter. The latest Federal Reserve economic projections suggest that growth will rebound to an annual rate of 2.1% in 2024, but accelerating growth may prove difficult unless the Fed can cut interest rates.
The U.S. Treasury yield curve has been inverted since mid-2022, a historically strong recession indicator. U.S. credit card debt stands at more than $1.1 trillion, and delinquency rates on that debt recently hit their highest level in more than a decade. Auto loan delinquencies are also on the rise, another potential red flag that U.S. consumer strength is deteriorating. A 4.3% unemployment rate is not historically high, but it is the highest U.S. unemployment rate since October 2021.
DataTrek Research co-founder Nick Colas says corporate bond spreads are another warning sign that economic growth could soon slow.
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“Corporate bond spreads hit ‘peak confidence’ in the U.S. economy one to two months ago and are now drifting their way higher to incorporate some slowing in economic growth,” Colas says.
“Corporate bonds are whispering ‘economic slowdown’ even as the S&P 500 hangs around record levels.”
The S&P 500 rallied in the first half of 2024 as investors cheered resilient earnings growth and anticipated that aggressive Fed rate cuts were just around the corner. However, the New York Fed’s recession probability model suggests there is still a 55.8% chance of a U.S. recession sometime in the next 12 months.
Jeff Buchbinder, chief equity strategist for LPL Financial, says earnings growth will be the key for the S&P 500 to maintain its positive momentum in the second half of the year.
“LPL Research believes stocks have gotten a bit over their skis, but earnings season may not be the catalyst for a pullback in the near term given all signs point to another solid earnings season, and stocks have mostly performed well during the peak weeks of reporting season in recent years,” Buchbinder says.
“We may not get an increase in second-half estimates over the next couple of months — that’s a lot to ask — but we should get a few points of upside and double-digit earnings growth for the second quarter on the back of technology strength.”
According to an Aug. 2 FactSet report, 78% of the S&P 500 firms that had already released Q2 earnings data (some three-quarters of those represented in the index) had reported actual earnings per share above analysts’ estimates. However, FactSet noted that the “magnitude” of earnings surprises had been below average, and some key firms’ positive earnings reports proved underwhelming to investors. For example, Amazon.com Inc. (ticker: AMZN) handily beat analysts’ estimates with earnings per share of $1.26 in the second quarter, but its stock slid due to weak third-quarter guidance and disappointing results in its advertising segment.
What to Invest in During a Recession
There are several general strategies investors can take to manage risk and take advantage of opportunities should the U.S. slip into a recession in 2024.
First, consider reducing exposure to volatile stocks and increasing cash holdings. Cash may not be the most exciting play, but it reduces market risk and provides financial flexibility if a recession creates potential buying opportunities in 2024. In addition, investors can earn 5.3% interest or higher on a one-year certificate of deposit right now, potentially locking in that yield even if the Fed begins cutting rates.
Certain stocks and market sectors are more defensive than others and tend to outperform the rest of the market during recessions. Utility stocks, health care stocks and consumer staples stocks are considered defensive investments because their earnings tend to be insulated from economic cycles and swings in consumer confidence.
In addition, certain individual stocks have outperformed during each of the past two U.S. recessions. Walmart Inc. (WMT), Abbott Laboratories (ABT) and Synopsys Inc. (SNPS) are just three examples of stocks that beat the S&P 500 in both 2008 and 2020.
Investors with longer-term financial goals have another alternative as well: Simply ignore a recession and stay the course.
James Demmert, chief investment officer at Main Street Research, says investors shouldn’t be spooked by a potential economic slowdown in the second half of 2024.
“Cash on the sidelines, alongside FOMO or ‘fear of missing out,’ will likely enter the stock market over the next six months, pushing prices even higher. While sometimes FOMO can be a sign of investors being too exuberant, we think this next round of FOMO will be driven by investors who were too cautious over the past six to 12 months,” Demmert says.
For now, he recommends investors stay focused on earnings growth, FOMC monetary policy headlines and stock market valuations. Demmert says the AI-fueled bull market is just getting started and could last seven to nine years, pushing the S&P 500 above 6,000 by the end of 2024.
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Recession 2024: What to Watch and How to Prepare originally appeared on usnews.com
Update 10/18/24: This story was previously published at an earlier date and has been updated with new information.
