Will They, Won't They: Is the US Really Headed for a Recession? What It Means for Your Investments

The US had robust growth following its rebound from the pandemic recession in 1H 2020, thanks to the pent-up demand across industries and near-zero interest rates that drove consumption and investments. 

However, the celebration was cut short as recession fear spread like wildfire amid the rising prices and interest rates in 2022. It coincided with the Russo-Ukrainian War and the slow port reopening; both worsened supply chain disruptions and shortages.  

And now, we are still seeing the combined effect of demand-pull and cost-push inflation. August inflation also exceeded market expectations, leading to the Fed’s hawkish view of another interest rate hike in 4Q. 

This, combined with OPEC oil cuts and rising prices, raises recession woes and stock market risks again. Nonetheless, the US economy is still performing much better than expected—much better than the rest of the world. 

With that, we will delve into the US economy and assess the probability of another recession. We will also measure its impact on the capital market and determine the optimal choice for investors. 

An Overview of the US Economy 

Macroeconomic volatility in the US started in the real estate sector, pushing median home prices to $386,300. With added supply chain disruptions amid the geopolitical tension in Europe, US inflation skyrocketed and set a new all-time high of 9.1% in 2022. 

In response, the Fed implemented policy tightening, raising interest rates to above 5% in just a year. It proved effective as it slowed down inflation by 29% at the end of the year. However, it contributed to the Silicon Valley Bank collapse, leading to the banking crisis in March. 

Even so, US economic indicators still show sprinkles of hope. Its Gross Domestic Product (GDP), for instance, remains the largest globally. In 2Q 2023, its nominal GDP rose by 4.1% year-on-year to $26.8T, while real GDP growth rebounded to 2.1% from 2.0% in 1Q 2023. 

Meanwhile, the labor market has cooled recently but remains manageable, with a low unemployment rate of 3.8%. The actual number rose by 514,000 but was reasonable since it was driven by 597,000 individuals with no work experience. 

Lastly, August inflation rose to 3.7% from 3.2% in July, exceeding market expectations. Despite this, core inflation decreased to 4.3% from 4.7% in the previous month. It shows that overall inflation is decelerating if we exclude the impact of oil and food price volatility. It is no wonder the Fed held rates steady during its September meeting. 

Is the US headed for a recession?

The Fed kept interest rates unchanged despite the hotter-than-expected August inflation. However, it left open the possibility of another rate hike by 4Q 2023. With that, concerns about the combined effect of elevated prices and interest rates resurface. The increasing oil prices amplify it as supply cuts continue to outweigh demand uncertainty. 

And now, the question that’s been bugging millions of households is whether or not the US is headed for recession. There is no foregone conclusion. 

Economic growth may be slower than in 2022, but the recession probability remains low. Even financial institutions like the Asian Development Bank (ADB) and S&P Global Rating are optimistic. The ADB even upgraded its US growth outlook from 0.9% in its April report to 1.9% in September. While the current situation appears unnerving to many, various factors must be considered before a recession occurs. 

First, today’s housing market greatly differs from the events before the Great Recession. One of the perfect examples is the absence of speculative mania and overselling of properties that led to the bankruptcies of many property builders, mortgage lenders, and homebuyers. 

Second, property shortages remain high. The housing market started the year short of 6.5 million units. The number increased to 7.3 million in April, showing increased demand amid the elevated median price. According to the latest report of Norada, the housing shortage ranges from 5.5 million to 6.8 million units, leading to the increasing demand-supply gap every year. 

This phenomenon can be attributed to slow property construction over the past decade. On a lighter note, it also indicates the conservative approach of property builders to real estate market recovery and boom. Information on loans has also become more accessible to potential buyers and investors. As such, it will be easier for the market to manage property price corrections. 

Third, the USD remains much more robust than other major currencies, such as Euro, Pound, and Yen. Despite the August uptick, it continues to set new 10-month highs as inflation decelerates. Also, the Fed's hawkish stance has helped stabilize US treasury yields. 

The US dollar maintains its strength with another potential rate hike combined with lower-than-the-global average inflation. Even better, higher rates may entice more investments. Thus, it leads to higher capital inflows, increasing the demand for USD and allowing it to outperform other currencies. 

Lastly, holiday spending in the fourth quarter may mitigate an economic slowdown. And in turn, the potential rate hike will be a prudent move to offset the impact of spending splurge on inflation. Even better, the US remains the top remittance source, which may increase as Christmas approaches. This will increase the demand for the US dollar and further strengthen its relative value. 

How Recession Woes Impact Investments 

As the adage goes, “What goes up must come down.” The US growth remains slower than in 2022, so it’s natural for investors to worry about falling bond yields, stock prices, and property value. You can expect higher volatility as investors become reactive to news that may affect prices. 

Depressions and recessions are generally unfavorable to investments, particularly stocks. These are more sensitive to macroeconomic changes. One of the most perfect examples is the US stagflation in the 1970s, which can be compared to the current situation. It lasted nearly two years, leading to a 52% stock market drop. The events from the Dot-com bubble burst to the Global Financial Crisis sent the stock market plunging by 54%. Lastly, inflation and recession fear in 2022 resulted in the S&P 500 losing 20% of its value.

Likewise, the forex market is impacted by recession since it may lead to capital outflows and dollar depreciation. 

Given all these, investors may become more risk averse, prompting them to pull a portion of their money out of the stock and forex market and inject it into the bond market. 

Investment Allocation Advice 

Warren Buffett once said, “Be fearful when others are greedy; be greedy when others are fearful.” While it is a contrarian view of the financial market, now is the perfect time to take risks and buy investments at a discount. Young and the Invested ere are the top investment picks you can consider.

REITs 

Given the sustained demand for properties after the market lull months earlier, REITs still have solid upside potential. The number of buyers still exceeds the number of available units, showing upside potential for property value. 

REITs are your go-to option if you prefer high dividend yields. Over the years, REITs have shown a low correlation with stock market volatility, given their lower standard deviation and beta. Consider American Tower Corp. (AMT) with 4.0% FW/dividend yield, Ventas, Inc. (VTR) with 4.4%, Simon Property (SPG) with 7.0%, and Realty Income (O) with 6.2%. All these are much higher than the S&P 500 (SPX) average of 1.55%. 

Concerning stock price returns, AMT remains the top choice. Its average annual returns over the past 16 years reached 10.2%, outperforming its peers. VTR has 1.1%, SPG has 1.4%, O has 4.3%, and the S&P average is 7.4%. Jensen’s Alpha of 0.03 also showed the AMT stock price changes were better than the S&P 500. 

Hospitality Stocks 

The pent-up demand for leisure travel remains the primary growth driver for hospitality stocks. In a recent survey, 60% of Americans said they would travel this autumn, with 71% planning to travel more frequently than last summer. 

A study by Forbes last month is slightly different but also shows favorable results for the industry. Nearly 50% plan to travel more this year, 38% will travel as much as they did in 2022, 8% will travel less, while the remaining ones have no concrete plans yet. 

Another primary growth driver is the prevalence of hybrid and remote work setups. This flexibility not only allowed people to spend more time with pets and family, it also gave us more chances to travel. Over 40% of employees with remote work flexibility increased their travel frequency during the week. Meanwhile, about a quarter of travelers said the current work setup helped them extend their travel duration. 

Marriott (MAR) and Hilton (HLT) are top picks for specific hotel stocks. Aside from their market dominance, their fee-based business model works best amid the tourism boom. This gives them an edge over another large hotel, Hyatt (H). They also show excess liquidity, which is crucial for capital-intensive companies. They maintain a decent Net Debt/EBITDA Ratio of 2.7x and 3.8x. 

MAR’s and HLT’s 15.1% and 12.7% stock returns are much higher than H’s 7.8% and SPX 9.2%. We can see how these stocks have outperformed the S&P 500 over the years using the Sharpe Ratio and Jensen’s Alpha. Their Jensen’s Alpha of 0.09 and 0.06 are better than H with only 0.1. 

HCM Stocks 

HCM stocks are also good choices, given their crucial role in the business sector and the labor market. They become essential as the world adapts to the digital revolution. As hybrid work prevails, effective payroll and workflow software is necessary to streamline business processes and optimize efficiency. 

A recent study by Forbes shows that 12.7% of full-time employees work from home, while 28.2% are in a hybrid work setup. Meanwhile, 16% of companies are operating fully remote. Hence, the demand for HCM stocks may increase by over 30% in 2025. 

Consider Automatic Data Processing (ADP) and Paychex (PAYX) for investment opportunities. They have increased price returns, averaging 14.8% and 12.3%, respectively, over the past decade. 

Meanwhile, Paycom (PAYC) has the highest returns of 40.7%, but the standard deviation of its daily price changes is too high at 46% versus ADP and PAYX, both with only 24%. As such, these two companies have less dispersion in price changes and pose less risks to investors.

Using the DCF Model, all three stocks have decent target prices. ADP has always been high but stays reasonable at $242.60 with a target price of $254.96, or a 5% increase. PAYC has a single-digit growth rate of 5% to $275.32, while PAYX has a 12% upside from $116.90 to $130.98. 

Forex

Forex can be an unusual choice, but it shows the current behavior of the US economy. The US Dollar Index (DXY) slipped from $113.33 in September 2022 to $99.58 in July 2023. We can attribute it to the impact of the policy rate hikes in other countries. However, it started to regain its strength with its better-than-global average GDP growth, inflation rate, and unemployment rate. As of this writing, the DXY is ranging from $104 to $106 and may increase further in anticipation of higher interest rates. 

Today, the USD remains stronger than other large economies like the Euro Area, Japan, and China. With the rising T-bill yields, the demand for the USD may increase further. Also, the US economy is much better than many other countries. With the US Fed’s hawkish view of another policy rate hike in 4Q, capital inflows and currency appreciation may take place. 

Bonds

Bonds are great for risk-averse investors. They have lower yields but better security against volatility. With slower economic growth and high interest rates, bond prices may go down, but yields may rise. Investors may choose Treasury Inflation-Protected Securities or TIPS since they have better hedges against valuation losses. Their face value is pegged to the CPI, adjusted to inflation rate changes, so they avert or at least lower depreciation even during a recession. 

Stay Ahead and Protected From Recessionary Headwinds 

With the still-elevated prices, interest rates, and tight oil supply, making economic predictions is more challenging today. It is even harder to optimize investment portfolio allocation. Even so, investors can get adequate knowledge from experts. Making sound decisions and balancing risks and rewards in the bear market will be easy.