More analysts, economists, and former Federal Reserve officials are predicting a recession – one that will stagger the U.S. economy. That’s frightening investors into selling profitable positions and going to the sidelines.

I say they’re wrong and getting out of the market now is a mistake.

So, in today’s Total Wealth, I’m telling you what these recession hawks are saying, why they’re saying it, and what the reality is.

Rising Voices

Goldman Sachs economists made news this week predicting the economy will see a recession in the next two years.

A Bloomberg survey of 77 economists in February had 15% calling for a recession this year or next. In March, 20% of respondents predicted a recession. April’s count is up to 27.5%, and Bloomberg expects the number of respondents calling for a recession to keep increasing.

In an early April Bloomberg interview, Larry Summers, Harvard economics professor and former Secretary of the Treasury, said the economy has always had a recession within two years whenever inflation was greater than 4% and unemployment was less than 4%.

Headline inflation measured by the Consumer Price Index (CPI) is up 8.5% now, and unemployment is down to 3.6%; so Summers is predicting we’re headed towards a recession.

Former president of the Federal Reserve Bank of New York and former vice-chairman of the Federal Open Market Committee , William “Bill” Dudley recently said a recession is “inevitable.”

And those are a tiny smattering of the rising cacophony of voices screaming recession ahead.

Tapping the Brakes vs. Slamming on Them Hard

The reason we’re hearing more recession predictions is the Fed missed its chance to “tap on the brakes” by raising rates slowly starting a year ago. This would have theoretically slowed economic growth and tempered inflation in the process. That could have resulted in a “soft landing” where economic growth slows enough to arrest rising prices but doesn’t throw the economy into a recession.

A recession, by definition, is when Gross Domestic Product growth turns negative, or, other words, the economy contracts for two or more consecutive quarters.

Since the Fed muffed braking 101 and frighteningly high inflation looks more embedded than “transitory,” the consensus among analysts, economists, and now Fed officials themselves, is those same officials are going to have to raise rates a lot higher a lot faster than anyone expected. And slamming the brakes that hard on economic growth will surely thrust the economy into a “hard landing” recession.

But all that’s theory. The reality on the ground is something altogether different.

So far, the Fed’s only raised the fed funds rate 25 basis points (one quarter of one percent). There is a chance the Fed will raise the fed funds rate another 50 basis points at either (or maybe both) of their next two meetings scheduled for May 3-4 and June 14-15.

But they don’t have to. They don’t have to do what an increasing number of commentators say they have to do, which now includes possibly raising rates by 75 basis points at their May meeting.

There two points to make here:

  1. Markets are already pricing in big jumps in the fed funds rate. Rate hiking talk is happening every day, and both equity and credit markets have digested a rate hike that would take the fed funds rate up to 2.5%, from 0.5% today, and they haven’t tanked. In fact, they’ve rebounded after selling off when it became apparent the Fed had to raise rates higher and faster.
  2. The Fed knows if they slam on the brakes too hard they will throw the economy into a recession. More importantly, they know if they’re too aggressive they could tank markets. The last thing the Fed wants to do is tank markets. Raising rates to dampen demand and stem inflation could result in a soft landing, but tanking markets guarantees a recession and the worst kind of hard landing.

The takeaway for nervous investors thinking about going to the sidelines ahead of a recession is, markets aren’t expecting a recession, and until they do expect one and selloff, stay invested.

And don’t worry about the Fed overshooting on rate hiking and tanking the market. They don’t want that to happen and do everything in their power to prevent a market meltdown, so stay invested people.

Since markets anticipate recessions and selloff ahead of them, just make sure you use trailing stops on all your positions to take your profits or limit losses if and when markets do selloff, for any reason, including anticipating a recession.

Another way to play recession fears is to buy good dividend paying stocks on companies that have good balance sheets as well as pricing power. For additional income, sell out-of-the-money call options on them.

If recession fear mongering stifles investment interest is equities and markets tread water and move sideways for some time, collecting dividends and additional income by selling covered calls makes perfect sense and will make you a lot of money.

That’s how you play recession fearmongering.

Cheers,

— Shah Gilani

Source: Total Wealth