Volatility may be back, but we don't see a U.S. economy tipping into recession

A "perfect storm" of drivers for the recent sell-off:?

After giving back 2% last week amid a late-week sell-off, equity markets remained under pressure on Monday, with the S&P 500 losing 3%. The Dow and Nasdaq set the bookends around that, with the former shedding 2.6% (1,034 points), while the latter closed 3.4% lower.* The difference between the performance of the three indexes highlights the role that technology stocks are playing in this decline. A confluence of factors came together to drive the recent sell-off:

• Rising U.S. recession worries, sparked by softer manufacturing data, higher jobless claims, and topped-off by a weaker-than-expected jobs report last week;
• Global equities saw particular pressure today, with Japan's Nikkei index falling 12%. The divergence in policy backdrops is likely at play here, as rates were recently hiked in Japan at a time when most other major central banks are pursuing rate cuts and looser policy settings. This is driving disruptions in the Japanese yen and currency markets that are likely also playing into the Nikkei's underperformance and could be spilling into global financial markets as yen-based loans funding international investments are unwound;
• Technology and growth stocks had moved rapidly in the first half of the year, and perhaps were due for some form of profit-taking or pullback. They are now leading to the downside, with declines in bellwethers like Apple and NVIDIA having a notable impact on the overall equity indexes. The technology and communication services sectors (the leaders for much of this year) were notable laggards. Defensive sectors held up better in the recent sell-off, though all sectors and equity asset classes were lower;
• Bonds offered a safe haven, providing a ballast to balanced portfolios as markets shifted to a "risk off" mode. U.S. Treasuries rose again today, pushing 10-year yields below 3.8% for the first time in more than a year; and
• Geopolitical worries and U.S. political uncertainties added to the cautious mood, with tensions rising in the Middle East on Monday amid threats of an Iranian retaliatory strike on Israel.

The drop in the stock market in recent days has been abrupt, but we don't think this is signaling a new, broader direction for the markets:

Here are a few takeaways from the moves occurring below the headlines:

• The headline reaction around recession worries is, in our view, far larger than the actual increase in the probability of recession. Put more simply, we don't think the economy is dramatically closer to recession today versus two weeks ago, when markets were near record highs. Last week's jobs report was underwhelming, but we don't think it indicates a collapsing labor market or consumer that is headed for hibernation. We think the economy is poised to slow, but the emergence of calls for an impending recession in recent days feels overdone, in our view.
• Mega-cap technology was the leader on the way up this year and has now reversed its role. Tech is lagging, and while that doesn't necessarily make the stock market drop in recent days any less palatable, it does tell us that a key driver in the decline is coming from the most overheated, fastest-rising segments of the market, as opposed to a more indiscriminate sell-off.
• We think there are some natural stabilizers at play that can help offset the fears that have prompted this pullback. In particular, we think this all but solidifies the Fed's ability to initiate its rate-cutting cycle in September. More accommodative monetary-policy settings and the commensurate drop we've seen in longer-term interest rates should provide support to the economy. The debate will rage on as to whether the Fed is able to react quickly enough to fully cushion the economy, but easier monetary policy is typically a favorable tailwind for financial markets.

The U.S. labor market is cooling, not collapsing:

The July payrolls report showed that the U.S. economy added 114,000 jobs, less than the 175,000 expected, with some modest downward revisions to prior months. The unemployment rate jumped to 4.3% vs. consensus of 4.1%, and wage growth increased 3.6%, the smallest gain in more than three years***. Our take is that the labor market is clearly adjusting to slower economic growth, and last months' data suggest that it might be doing so more rapidly than investors and policymakers are comfortable with, cementing expectations for a September cut. However, we would caution against reading too much into one month's data, and we would still characterize employment conditions as healthy for several reasons:

• Over the past three months payroll gains have averaged 170,000, which is a big step down from an average of 380,000 in 2022 and 600,000 in 2021, but about in line with the 180,000 average monthly gain during the last economic expansion from 2010 -2019***.
• At 4.3%, the unemployment rate is still historically low. In fact, it's lower than 90% of the time, with data going back to 1949***.
• The rise in unemployment has been largely a function of an increased labor force rather than a drop in employment. While job openings have come down from 12 million in 2022 to 8.2 million, they still comfortably exceed the number of unemployed, which currently stands at 7.2 million***.

Market pullbacks are always uncomfortable, but investors shouldn't get out of their seats:?

Volatility has returned after a particularly tranquil period in the markets through 2024. While a one-thousand-point drop in the Dow may appear worrisome, perspective is helpful during phases like this. Consider the following:

• Volatility is normal, if not healthy. Going back over history, the stock market, on average, experiences three 5% dips and one 10% correction per year.** So far in 2024, prior to the last few days, the market had only experienced one 5% pullback this year.**
• While the headlines might evoke a significant reaction, keep in mind that even with Monday's drop, the stock market (S&P 500) is down a little over 8% from its all-time high.* The S&P 500 is still up more than 8% in 2024 and has risen more than 25% since the pullback last October.*
• Bottom line: we're not dismissing the impact of this pullback, nor are we suggesting it will reverse course as quickly as it emerged. In fact, markets may remain choppy through a seasonally weaker September and October period and into U.S. Election Day. But to us this feels more like a natural pruning of markets following a prolific rally through most of 2024 than a signal of a deterioration in the fundamental foundation of this bull market.

From our view, the economy does not appear poised to tip into outright recession soon, corporate profits are still on the rise, and the Fed is about to start cutting rates. That combination has not undergone a meaningful negative change in the last week, despite what the headlines and the sell-off in stock prices might otherwise suggest. We could see volatility continue and weakness persist a while longer as some of the froth is blown from the top of the market that rallied sharply this year, but we think the underpinnings of this bull market are intact, as we believe this will ultimately prove to be a temporary decline.

Read the full 8/5/24 Daily Snapshot here: https://www.edwardjones.com/us-en/market-news-insights/stock-market-news/daily-market-recap

Source: *FactSet, **Edward Jones calculations, ***Bloomberg

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