Recessions Signs Rise; Moody's Turns The Bond Market Blue

Equities were down slightly for the week amid a Moody's downgrade of U.S. government debt to AA+, joining S&P and Fitch. Economic data indicates a slowing economy, with Target reporting sales declines, retail businesses reducing their footprint, and rising delinquency rates across various loan categories. While initial unemployment claims remain steady, continuing claims are rising, and inflation appears contained with the CPI approaching the Fed's 2% target, suggesting the Fed may be behind the curve and increasing recession risks.

Analysis

U.S. equity markets experienced a downturn, with large-cap indexes declining approximately -2.5% and the small-cap Russell 2000 falling -3.5% for the week, pushing its year-to-date performance to -5.26%. Performance among the 'Magnificent 7' tech stocks was largely negative for the week, with Alphabet (GOOG) as the sole exception; year-to-date, Apple (AAPL), Tesla (TSLA), and Alphabet (GOOG) are down double digits, while Microsoft (MSFT) and Meta (META) are the only gainers. This market weakness coincided with Moody's downgrade of U.S. sovereign debt to AA+ from AAA, aligning with previous downgrades by S&P in 2011 and Fitch, though the immediate market reaction to this fiscal development appeared muted, raising concerns about continued fiscal laxity given the U.S.'s unfavorable Deficit/GDP and Gross Debt/GDP ratios compared to other AA+ rated nations. Concurrently, economic indicators point to a significant slowdown: the University of Michigan's Consumer Sentiment and Expectations indices have fallen to levels comparable to the Covid Recession, consumer savings are depleted (savings rate at 3.9% versus a 9% norm), and retail activity is contracting, evidenced by Target's (TGT) -3.8% year-over-year sales decline, a net six million square feet vacation by retail businesses in Q1, and a -0.2% real decline in April retail sales. Rising delinquency rates across credit cards (12.3%, a 14-year high), auto loans (5%), HELOCs (nearly doubled to 1%), and student loans (over 10 million defaults) further underscore consumer financial stress, corroborated by a New York Fed survey indicating 1 in 9 respondents may miss a minimum debt payment. Corporate adjustments include Walmart (WMT) cutting 1,500 jobs, and broader consumer behavior shows a pullback in vacation spending. The housing market is also softening, with existing home sales falling for three consecutive months to levels below the October 2008 Lehman collapse, and median prices declining for four straight months. While initial unemployment claims remain stable (220K-240K), continuing claims have surpassed 1.9 million, suggesting increased difficulty in job seekers finding employment and a slowdown in new hiring. In contrast, inflation shows signs of containment, with the April CPI at +2.3% year-over-year, nearing the Fed's 2% target, and the three-month trend at a +1.6% annual rate (or +0.7% if adjusted for current rents per Rosenberg Research). This confluence of weakening economic data and moderating inflation suggests the Federal Reserve may be operating with a lag, potentially underestimating the heightened probability of a recession.

Key Decisions for Investors

• Investors should exercise increased caution regarding equity allocations, particularly within cyclical sectors and small-cap stocks, given the pervasive signs of economic deceleration and deteriorating consumer credit health.
• Monitor leading indicators such as continuing unemployment claims, consumer delinquency rates, and retail sales figures closely, as these suggest a higher probability of recession than currently priced by the market.
• Consider the implications of moderating inflation, which is approaching the Federal Reserve's target; this may limit further monetary tightening and could shift policy focus if economic weakness intensifies, potentially creating opportunities in fixed income.
• Adopt a selective approach to technology investments, recognizing the significant performance divergence among large-cap tech stocks (e.g., MSFT, META positive YTD vs. AAPL, TSLA, GOOG negative YTD), and prioritize companies with strong balance sheets and resilient earnings power in a challenging macroeconomic environment.