In the financial world, the term “soft landing” is often used to describe a situation in which the Federal Reserve (Fed) successfully raises interest rates without causing a recession. This narrative currently dominates the market, with stocks trading at record highs and the Fear-Greed Index showing extreme greed. However, it is essential to carefully examine the data and prepare your portfolio for the possibility that this narrative may not unfold as expected.
Understanding the soft landing narrative
Historical context of soft landings
The soft landing narrative is not a recent development. It was also the dominant narrative before the onset of the last two non-COVID recessions, in 2000 and 2008. Despite the positive outlook, these periods were followed by severe recessions. This historical context serves as a reminder that while a soft landing is feasible, it is not guaranteed.
The role of the labor market
The main justification for the soft landing narrative is the robustness of the labor market. Current data indicates that unemployment is at a low level. However, a detailed examination of the history of recessions reveals a pattern: Unemployment is typically at cycle lows when a recession begins. This pattern has remained consistent over the last 11 recessions.
Signs of weakening in labor statistics
While low unemployment rates may imply a strong economy, other jobs statistics suggest a potential weakening. Employers often reduce their employees’ working hours before resorting to layoffs during a recession. Current trends in hours worked indicate a worrying decline, which could be an early warning sign of an impending recession.
Employment as a lagging economic indicator
Employment is often viewed as a lagging economic indicator, meaning it tends to change after the economy as a whole has already begun to follow a specific trend. Average monthly job growth for the four quarters leading up to the recession is generally strong. It is only when the recession actually begins that job losses occur, and when they do, they can be severe.
Market behavior and probability of recession
Despite potential warning signs, the market currently behaves as if there is no possibility of a recession. Stocks are at all-time highs and the fear-greed index shows extreme greed. However, history shows that over the last ten recessions, stocks have averaged a 31.5% decline.
Build protection into your wallet
This analysis is not intended to instill fear or predict an inevitable recession. Instead, it serves as a reminder to be smart and proactive in managing your investments. Incorporating some protection into your portfolio can help you safeguard your assets in case the soft landing narrative doesn’t materialize as expected. This could involve diversifying your investments, keeping a portion of your portfolio in safer assets, or seeking professional advice to help you weather potential market downturns.
Frequent questions
Q. What is the “soft landing” narrative?
In the financial world, the term “soft landing” is often used to describe a situation in which the Federal Reserve (Fed) successfully raises interest rates without causing a recession. This narrative currently dominates the market, with stocks trading at record highs and the Fear-Greed Index showing extreme greed.
Q. What is the historical context of soft landings?
The soft landing narrative is not a recent development. It was also the dominant narrative before the last two non-Covid recessions, in 2000 and 2008. Despite the positive outlook, these periods were followed by severe recessions. This historical context serves as a reminder that while a soft landing is feasible, it is not guaranteed.
Q. What role does the labor market play in the soft landing narrative?
The main justification for the soft landing narrative is the robustness of the labor market. Current data indicates that unemployment is at a low level. However, a detailed examination of the history of recessions reveals a pattern: Unemployment is typically at cycle lows when a recession begins. This pattern has remained consistent over the last 11 recessions.
Q. Are there any signs of weakening in labor statistics?
While low unemployment rates may imply a strong economy, other jobs statistics suggest a potential weakening. Employers often reduce their employees’ working hours before resorting to layoffs during a recession. Current trends in hours worked indicate a worrying decline, which could be an early warning sign of an impending recession.
Q. How is employment viewed as an economic indicator?
Employment is often viewed as a lagging economic indicator, meaning it tends to change after the economy as a whole has already begun to follow a specific trend. Average monthly job growth for the four quarters leading up to the recession is generally strong. It is only when a recession begins that job losses occur, and when they do, they can be severe.
Q. How is the market dealing with the possibility of a recession?
Despite potential warning signs, the market is behaving as if a recession is impossible. Stocks are at all-time highs and the fear-greed index shows extreme greed. However, history shows that over the last ten recessions, stocks have averaged a 31.5% decline.
Q. How can I protect my wallet?
Incorporating protection into your portfolio can help you safeguard your assets if the soft landing narrative doesn’t materialize as expected. This could involve diversifying your investments, keeping a portion of your portfolio in safer assets, or seeking professional advice to help you weather potential market downturns.
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