What does this mean for stock markets

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Has the United States entered a recession? – Photo: Getty Images

The US economy has contracted for two consecutive quarters, placing it in a technical recession. Stock markets should behave differently now, creating new opportunities for investors.

The forward-looking behavior of equity markets means that broader equity markets have already priced in this downturn at the start of the year and have now started to recover. The S&P 500 (US500) and Nasdaq 100 (US100) have gained almost 7% and 9% respectively over the past month.

During a recession, stocks in the energy and consumer sectors are likely to face devaluation as they begin to post weaker sales numbers. As tech stocks are expected to rally, the market is rushing to buy quality stocks at discounted prices. As evidenced by the rally in Apple (AAPL), Alphabet (GOOGL) and Microsoft (MSFT) stocks in recent weeks.

Nasdaq 100 (US100) Price Chart

Are we in a recession?

Although there is no official definition of a recession, the general rule is that an economy is in a recession when its gross domestic product has contracted for two consecutive quarters. The US economy contracted by 1.6% in the first quarter of 2022 and by 0.9% in the second quarter, putting it in technical recession.

David Jones, an analyst at Capital.com, explains why this has not yet been officially declared “it’s a strange technicality as to whether or not the United States is in a recession. It’s up to the National Bureau of Economic Research to officially call it. He adds that “some would point to the fact that there is not high unemployment, but to me the United States is in a recession – we can’t change the rules as we go.”

Why is the stock market going up?

Although the economy contracted in the first half of 2022, the stock market in recent months has tilted. The S&P 500 (US500) and Nasdaq 100 (US100) gained almost 7% and 9% respectively.

This is because stock markets are forward looking. Investors had already started pricing in a potential recession earlier in the year when the stock market began to see a sell-off.

As Jones puts it, “Indexes like the Nasdaq are down about 20% this year and priced in the ongoing economic downturn.”

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Now that the contraction has happened, stock markets seem to have turned around. Jones says the catalyst for this may have been decisions made by the Fed: “With the narrative around this week’s Fed meeting suggesting that interest rates may not be rising as aggressively as they did, investors seem to have taken a bit of courage from that.”

For investors, he says, “The real test for indices now is when they sell – how far do they go? If indices such as the S&P 500 hold above the lows of the year so far, it looks like the market is once again in “buy the dips” mode.

S&P 500 (US500) Price Chart

How will the different sectors behave?

Although the broader stock markets are recovering, individual sectors of the stock market create different opportunities for investors as the economy goes through new cycles. Some key points to note for all market watchers like:

  1. In anticipation of a recession, equity investors typically flee to defensive sectors, such as consumer staples, industry and health, according to SSGA research. These sectors are likely to experience slower growth once the economy is in recession. Indeed, the start of the year saw companies such as Walmart (WMT), Coca Cola (KO) and Kraft Heinz (KHC) outperform the market, only to see their values ​​deflate in recent months.
  2. When a recession approaches, investors start buying stocks in sectors such as energy, a sector that historically benefits from inflation that precedes a recession due to its ability to pass costs on to customers. TotalEnergies (TTEF), Chevron (CVX) and ExxonMobil (XOM), Shell (RDSa) and BP (BP) all outperformed the market by posting historically high revenues in the last quarter. As the recession continues, the energy sector may create a short selling opportunity as demand slows. Jones comments, “If the downturn continues, I expect energy markets to pull back, which would normally impact the share price of these companies.” However, due to the unique supply constraints seen in recent months, resulting from the Russian-Ukrainian war and supply chain disruptions, it is possible that the energy sector will only decline so far.
  3. During the recession itself, it is the technical and financial sectors that suffer. This is when the market begins to price in the reduction in borrowing and disposable income. JPMorgan (JPM), Goldman (GS) and Morgan Stanley (MS) all saw their stock values ​​decline after disappointing earnings in the second quarter of 2022. It’s a similar story for tech stocks, however. Jones says: “If investors accept risk again, some of the high-tech companies that have been particularly hard hit over the past 8 months or so could see a decent recovery.” Tech stocks such as Apple (AAPL), Alphabet (GOOGL) and Microsoft (MSFT) have started to edge higher after seeing a selloff a few months ago.

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