Crypto News: It may be a vibecession, but it's not an actual recession

I'm getting that deja vu feeling. Suddenly everyone is talking about a 'vibecession' in the US, with the understandable fear that it signals an actual recession is not far behind. I share those concerns because of the risks from the huge policy shifts under US President Donald Trump and his burgeoning trade war. But the US economy still looks remarkably resilient. So it's worth remembering that in 2023 we had a period of increasingly negative sentiment, a vibecession, that didn't so much as produce a hiccup in the pace of economic growth.

The answer, if you're an investor then is that you just have to wait and see how the hard data shakes out — which is the same approach that Federal Reserve Chair Jerome Powell emphasized last week. In the meantime, I'm waiting for the inflation data to tell us if the stagflation threat is real because that's where the downside risk is for stocks, bonds, and the overall economy. In this newsletter edition, I want explain why. First here's a preview of my chain of thought.

For investors slowdowns don't really matter a ton. Inflation, recessions and fed hiking cycles do. Even in a stagflationary scenario, the biggest downside risk is inflation that leads to rate hikes and a recession.
So care about inflation. And only care about the vibecession if it leads to an actual recession. The 2023 experience is instructive about how much you can follow soft data like consumer-sentiment surveys to make predictions about the future. You can't.
Given that experience, we need to look at the hard data for harbingers of weakening growth. Initial jobless claims is my first port of call. And they have yet to weaken a lot.
Looking at four potential outcomes, I still see more downside risk than most. But I also see the risks as slightly more favorable than I did last week, which is bond-negative but neutral to positive for stocks. Near-term catalysts will come from this week's personal consumption report and next week's unemployment report.

The late 1970s were just fine for investors. But only in nominal terms

Take a look at this chart of the S&P 500 during the 1970s.

You can see the chart goes up and to the right when the economy is expanding (the white sections of the chart). The hit to the market came during the four recessions that bookended the 1970s.

Here's the thing though. When I crunched the numbers for returns not including inflation during the late 1970s, it wasn't horrible but it didn't look that good either. The lowest number I got for decade-long S&P 500 returns was -12.6% near the end of 1978. On the cusp of the recession in January 1980, the S&P 500 had even gained some 34% over the prior decade.

What's the takeaway? First, it's recessions that kill market returns. Without a recession, the stock market pretty much goes up.

Second, that works in nominal terms, sure. But if you're looking for an inflation hedge, it's not equities. In real terms, you don't get killed by moderately high inflation, but you're not happy about your investments either. The higher inflation is the more downside risk you have. To put it in perspective, note that during the 1970s decade the highest return for the S&P 500 for ten years in excess of inflation was 42%. And that was back in 1972 before inflation ravaged the global economy. For most of that decade, rolling decade-long real returns for stocks were negative, as low as -54% in 1978, smack dab in the middle of a bull market.

And by the way, the same is kind of true for bonds too. If you just eyeball the 10-year yield during the stagflationary period, long-term yields didn't get crazy until Volcker came in and started raising interest rates aggressively in 1979.

Of course, you lost out in inflation-adjusted terms. But the real losses only kicked in when the Fed went ballistic.

Stagflation hurts. Recessions during stagflation really hurt

As Jeremy Grantham said a few weeks ago "low inflation, the market loves it. High inflation, it hates." You simply cannot do well as in investor when inflation is high. In the near term, companies' earnings growth can't keep up with their rising costs. And the high levels of inflation erode the future value of earnings over the longer-term. That leads to negative returns when adjusted for inflation as we saw throughout the 1970s. And bonds get hit too since rising inflation means higher bond yields. So you lose on both sides until a recession hits. But while bonds do well during a downturn, they never compensate fully for the devastation stocks feel. The result is returns in excess of inflation that are poor even as the economy expands. They're awful when recession hits.

Fears about repeating that 70s show are why we had a stock market correction. People are worried not just about stagflation, but a stagflation that leads to a recession. I've been saying for a few weeks now that this correction was just market "jitters." It's a re-pricing of downside risk due to a recognition that Trump is serious about tariffs, he's serious about deporting people and he is serious about laying off government workers — a policy mix that should decrease growth and raise inflation, essentially create stagflation. That's created pretty negative consumer sentiment. But this is just a risk to the economy. The hard data haven't actually turned down that much yet.

I just looked back at the data after a similar experience three years ago when I wrote a piece about vibecessions as a bad indicator for the economy. It's that look-back that led to the title of this piece: vibecessions aren't actual recessions. In fact, I would go further. They're not even predictive of the economy. Just because people say they're fearful or dejected about future economic prospects doesn't mean they stop buying stuff. And it doesn't cause a recession.

Look at GDP growth in the six months after I wrote about a vibecession in 2023. Not only did a vibecession not predict an actual recession, we didn't even get a slowdown. Growth actually increased. So you can't predict the future based solely on weak consumer sentiment. That has to translate into tangible actions that show up in hard economic data about employment, investment and output.

Jobless claims have always been my go-to

I've probably said this before but jobless claims are our best high-frequency economic data point. Not only does it tell whether companies in the US are feeling so much risk that they have to lay off workers, it also gives a sense of the potential hit to consumption. And the continuing number of jobless claims give us a sense of how difficult it is to find employment after one has been laid off, something critical for the economic outlook if the federal goverment's layoffs keep going on.

The way I think about it is that there's a steady churn in the economy that yields a constant flow of initial claims for unemployment insurance every week. If that flow rises, it's a sign that companies are laying off more people, And if the number of initial claims rises enough, the resulting hit to consumption can help tip the economy into a recession. My rule of thumb is that a sustained rise of 50,000 initial claims in less than a year means recession. Back-testing that rule, it's held in every recession for which jobless claims statistics are available.

Here's what the numbers have looked like over the last three years.

We've seen two distinct periods of recession risk when the rise in claims was high enough to sit up and take notice. Both coincided with rising unemployment rates. And the second longer rise triggered the so-called Sahm rule, which says a recession was likely to follow because of the rise in the unemployment rate over the last twelve months. Former Fed economist and Bloomberg columnist Claudia Sahm, who invented that rule of thumb, told us last year the rule was meant to be broken. Just as she suggested, we have yet to see a recession.

So we've had the risk of recession but no actual recession. And my rule — can I call it the Harrison rule here? — has not been triggered, by the way. Right now, we're right about the same level we were six months ago and only up 15,000 or so from the recent lows. No recession threat.

Now we wait

So if you're an investor and the big thing you care about in terms of shuffling your portfolio allocation is inflation and recession, you're kind of in a holding pattern. Inflation is elevated but not horrible. And there are no signs of recession in the hard data yet.

Going back to the four potential economic outcomes I handicapped last week, I'd say all are still in play and the odds for more favorable outcomes are slightly better. I thought it was interesting that, in the Signal chat group which the Trump Administration inadvertently opened to a journalist, Vice President Vance mentioned holding off on military action to see how the economy develops. His exact words were:

There is a strong argument for delaying this a month, doing the messaging work on why this matters, seeing where the economy is

What that tells you is that the economy-retarding elements of the Trump economic plan are not on auto-pilot. There may be some calibration in order to prevent a recession. So, if I handicapped it today, I'd add 5 percentage points to the two best outcomes and take that away from the two worst economic outcomes.

For equities, that means the correction was a blip that won't be validated unless and until we see economic slowing or higher inflation. Shares can trade neutral to higher as long as inflation numbers, economic growth numbers and earnings reports play along.

The first potential catalysts I see in the near term is the personal consumption expenditures (PCE) data this Friday. Not only do we get another month's read on how consumption is holding up, we will also get the Fed's preferred inflation metric, which is expected to come in at 2.5%. What's more, this inflation report will help decide whether inflation truly has been moving back to target as the Federal Reserve has claimed.

Anything over 2.5% says that not only is the Fed's confidence misplaced but that any price rises associated with the burgeoning trade war will make the numbers even higher. If either that headline figure or the one excluding food and energy surprise to the upside, stocks will get hit, and potentially go back into correction territory. Making matters worse, bonds will get hit too.

At the end of next week, we get another jobs report. The unemployment rate is expected to rise again to 4.2%. But it's hard to say how the market will react until we know what the inflation outlook looks like. In that sense, the PCE data are more important and a potentially bigger catalyst.

The big takeaway then is not that consumer sentiment doesn't matter. It does matter as it does tend to fall before recessions. But it can also fall a lot without triggering a recession too. So it's just part of the overall picture — and not the one we should be focused on right now.