A volatile week ended with the major indices regaining most of the losses from Monday’s sharp sell-off. The drop on Monday, which saw the S&P 500 down 3 percent at close, was a carryover from the prior week, when weaker than expected employment data and signs of a slowing economy had investors fearing a recession may be on the horizon. Concerns of an economic contraction have since eased as many investors were cheered by fewer than expected initial jobless claims last week. Additionally, there was a growing sense that the Fed has the greenlight to cut rates aggressively at its September meeting and may approve a cut beforehand should employment show more signs of economic weakness. In some ways, last week wasn’t all that different than what we’ve been highlighting for the past several months. Yes, volatility spiked in the market; and yes, the size of the sell-off after the weaker than expected jobs data was unusual. However, just as we’ve seen for most of this year, concerns sparked by weak economic news eventually faded as investors found a “but” to counter the latest data point.
The casting aside of warning signs about the economy for much of this year has been bolstered by two factors. First, as we noted in last week’s commentary, many normally reliable economic indicators have been signaling an approaching recession for up to two years—yet economic growth has continued. And second, while parts of the economy showed signs of strain, the job market remained robust, which many reasoned would help the economy stay afloat. However, the recent climb of the unemployment rate to 4.3 percent has triggered the so-called Sahm rule and weakened the case for a soft landing. This rule shows that since 1960, every time the three-month moving average unemployment rate rose by 0.5 percent or more from the prior 12-month low, a recession followed. While some on Wall Street have countered that aggressive rate cuts by the Fed could still offset any momentum of an economic slowdown, we believe the Federal Open Markets Committee may be more conservative in reducing rates than many expect. That’s because consumers remain in relatively good financial shape, and inflation pressures have eased but not completely dissipated.
While we continue to believe the economy is likely headed for a contraction based on a wide array of forward-looking indicators, we also acknowledge that it is impossible to predict with any certainty when a recession may arrive. Indeed, the many head fakes from the data since COVID have understandably made investors somewhat desensitized to many of the warnings we’ve seen. But while it’s natural that there are differing opinions on how long the current growth cycle can continue, we believe it is fair to say that risks in the economy—and the markets—have risen as the weight of higher interest rates continue to act as a drag on growth. As such, we believe investors would be well served by asking “what if?” What if the labor market, which is widely considered a lagging economic indicator, falters further? What if the previously reliable indicators are still directionally right even if the timing is delayed? By no means are we suggesting that these what-if questions should prompt you to abandon your investment plan. Instead, we believe the acknowledgement that economic risk is heightened and, given signs of a weakening labor market, that we are closer to a recession now than we were at the start of the post-COVID economic recovery should encourage you to lean into your investment and financial plans.
Put another way, we suggest the best way of dealing with uncertainty is to 1) develop a financial plan and 2) always adhere to diversification. Work with your advisor to develop a financial plan that you follow through both good times and bad. Embedded within that plan is the reality that life and markets are uncertain. Any resulting asset allocation acknowledges that potential volatility. We believe the best manner to deal with that volatility is through diversification, which acknowledges that no one knows for certain what will happen. And while diversification is often viewed as a defensive tool, we believe it should be considered an all-weather approach that allows investors to have exposure to asset classes that typically perform well even as others lag. At Northwestern Mutual, our advisors have tools to help prepare for all of life’s challenging events and uncertainties.
About the Author:
Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.
