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Three months ago we said the economy would need time to sort itself out before the stock market could have sustained recovery. We retain that viewpoint despite the market’s positive performance in the first quarter. Some people describe the market in recent months as resilient. We think bipolar is a better description.

Yes, the S&P 500 gained 7% for the quarter. But that increase was largely concentrated in the technology sector which grew over 20%. Some investors assumed or hoped the Federal Reserve was done with interest rate increases. They chose to favor technology which had perceived value after its pummeling in 2022. But most S&P 500 sectors were flat or negative. Absent the technology blip, the broader market is uncertain and unsettled.

At Hudson Advisors, we feel more cautious than optimistic about the immediate period ahead. We do not assume the Fed is done with rate increases. We accept their pledge to do what it takes to beat down inflation. We are not overly concerned that broad problems exist in the banking system. But we think credit will tighten further for small business and consumers. We think the outlook for corporate earnings is weakening. We think the probability of a recession this year – or what some are calling a “hard landing” – is fairly strong. The market will pause rather than move further ahead in this period.

The Economy:  We agree with a recent economic analysis by the U.S. Conference Board. They predict a mild recession in the second half of the year. Here is their rationale:

The U.S. economy is still strong at the moment. Annualized GDP for the first quarter is estimated at 1%. Both employment and consumer spending are healthy. The March CPI headline number rose 5% year over year, slowing a full percentage point from a rise of 6% in February. As a result, the Fed could possibly raise rates another 25 basis points at its next meeting. It is possible that additional rate hikes will be needed.

Then we have the problems in the banking system. The Conference Board does not see widespread bank failures. But managing balance sheets in the face of higher interest rates will lead to tighter credit for small businesses and consumers which will dampen the economy.

The Board forecasts the economy slipping into recession during the second half of the year. However, because the labor market is still vibrant, the recession will be mild. Looking to 2024, the volatility that has dominated the U.S. economy over the pandemic period will diminish. Overall GDP growth should return to the 2% range of 2019 and previous years. Inflation will drift down to the 2-3% level and the Fed will cut rates back to below 4%.

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