The U.S. Economy’s Path & Crisis Investing

Archive edition · Market data and company circumstances reflect 7 September 2024, when this newsletter was sent.

U.S. Economy on Track for a Soft Landing?

In recent months, much of the market buzz has centered around the potential for the U.S. economy to achieve a "soft landing." But what does that really mean?

A soft landing refers to a scenario where the economy slows down just enough to reduce inflation but avoids falling into a recession.

A soft landing is typically defined as a period when real GDP growth averages below the economy’s potential growth rate (currently 2.0%, according to the Congressional Budget Office) for three consecutive quarters, with none of those quarters showing negative growth. If the U.S. economy grows at an annualized rate of 1.5% in Q3 2024, as currently projected, it would meet this definition of a soft landing.

Two years ago, when the Federal Reserve began its aggressive campaign to combat inflation, many doubted this outcome was possible. However, inflation has since eased, job growth has moderated yet remains positive, and the U.S. has sidestepped a recession.

While inflation is still above the Fed’s 2% target, it’s close enough that Fed Chair Jerome Powell hinted at a potential rate cut during his recent speech in Jackson Hole, Wyoming.

As Fed cuts rates, it would mark the first reduction since the pandemic-induced recession in March 2020. This would also signal the conclusion of the Fed’s two-year tightening cycle, which began in March 2022.

What Comes After a Soft Landing?

Historically, the U.S. economy has tended to accelerate after a soft landing. This pattern could repeat in 2025, particularly if the Fed lowers rates.

A similar situation occurred in 1995, following another aggressive Fed tightening cycle. Despite various financial crises, the economy continued to grow robustly until 2000. During that period, the Fed made several adjustments to interest rates, ultimately maintaining a balance that kept inflation at or below its 2% target.

U.S. economic growth has accelerated after past soft landings. (Source: Capital Group)

However, today’s economic landscape is different. The unemployment rate is currently at 4.3%, compared to 5.5% in 1995, suggesting less room for a prolonged expansion. Additionally, higher debt levels and demographic shifts could mean that the same interest rates exert a greater drag on the economy now than they did then.

On the other hand, factors like fiscal stimulus, reshoring of supply chains, and investments in AI could help mitigate the impact of higher interest rates. So far, the economy appears to be handling these rates well. The labor market remains resilient, with recent increases in unemployment driven largely by new entrants into the workforce — a sign that aligns with what Fed officials would consider a soft landing.

We May Still Not See Ultra Low Interest Rates…

Despite market expectations for significant rate cuts by the end of the year and into 2025, there’s a good chance the Fed may not be as aggressive. If the economy continues to grow and job creation stays strong, the Fed might avoid further cuts to prevent overheating, especially if inflation remains above 2%.

Market expectations for Fed rate cuts may be too ambitious. (Source: Capital Group)

If the U.S. economy continues to grow above its potential early next year, the Fed might decide to pause any further changes, focusing on maintaining price stability after the worst inflation spike in 40 years.

Even with fewer rate cuts, this environment could still be favorable for both stocks and bonds. A growing economy would likely support equity prices, while rates could stay at levels that offer bond investors a viable alternative to equities.

Investing during Times of Crisis

In the early days of the Covid-19 pandemic, the cruise industry faced an unprecedented crisis. Ships were stranded at sea as ports around the world refused entry, trapping passengers on board and fueling baseless rumors that these vessels were epicenters of the virus.

Within a month, stock prices of major cruise lines plummeted by about 80%. It was a difficult time to be in the cruise business.

Yet, this crisis presented a unique opportunity for contrarian investors. Despite widespread belief that the cruise industry would never recover, some investors saw the panic as an overreaction and concluded that the major cruise lines had the financial flexibility to survive the shutdown.

Travel and leisure companies have rebounded strongly from the pandemic.

This conviction led these investors to identify several attractive investment opportunities, and today, the cruise industry is thriving. More people are cruising than before the pandemic, driven by pent-up demand and enhanced experiences on board.

Contrarian Investing

The cruise industry’s comeback is a classic example of crisis investing — a strategy that requires the ability to question conventional wisdom, take calculated risks, and conduct deep fundamental research.

Boeing, for instance, has faced significant challenges, from safety issues with its 737 MAX to supply chain disruptions. Despite this, Boeing is positioned as one of only two dominant aircraft manufacturers in the world presents a long-term opportunity, especially given the backlog of orders for its planes.

Seizing Opportunities During Recessions

Recessions, though painful, often lead to undervalued stocks and potential investment opportunities. Over the past 34 years, U.S. stock markets have consistently rebounded strongly from recessions.

Steve Watson, a portfolio manager with New Perspective Fund®, finds that economic downturns can create an abundance of distressed companies worth considering.

U.S. stocks have shown resilience after the past four recessions

Watson’s experience covering European utilities in the early 1990s exemplifies this. At the time, U.K. utilities were deeply unpopular due to privatization and a weak economy. However, Watson saw their low valuations as an opportunity, leading to significant gains when the sector rebounded after the 1992 elections.

The Long View: Focusing on Fundamentals

Watson’s investment style, shaped by years of experience, emphasizes the importance of looking beyond short-term market turmoil. He believes that market swings, driven by investor psychology, can create opportunities for those with a long-term perspective.

While not every crisis investment pays off — as Watson experienced with banks after the 2007–2009 financial crisis — the potential rewards can be significant for those who see beyond the current challenges to identify where value will re-emerge.

Crisis investing is not for the faint-hearted, but for those willing to dig deep, question the status quo, and maintain a long-term outlook, the rewards can be substantial.

As Watson puts it, “Everyone loves a good comeback story.”

Archive note

This article preserves the analysis in our weekly newsletter sent 7 September 2024. Market prices, forecasts and company circumstances reflect the time of publication and may have changed.

This material is general information, not personal financial advice or a recommendation to trade. Investing and trading involve risk, including loss of capital.