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Wells Fargo Investment Institute - May 25, 2022
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by Scott Wren, Senior Global Market Strategist


Key takeaways

  • Over the last few months, we have made a number of strategy adjustments based on the rapid aging of the economic expansion.
  • A central point of our guidance has been that investment opportunities typically arise throughout an economic cycle, but a recession requires extra patience.

Over the last few months, we have made a number of strategy adjustments based on the rapid aging of the economic expansion. Factors contributing to this outlook include “stickier” price pressures than initially anticipated, leading to what will likely be aggressive Federal Reserve rate hikes, declining real (inflation adjusted) wages, rising long-term yields and mortgage rates, and a slowing housing market. Our goal has been to lower portfolio risk by reducing exposure to asset classes and sectors most sensitive to the ebb-and-flow of the economy. For now, we want to play less “offense” and more “defense” as we foresee the economy slowing in coming quarters.

High-frequency data, defined as economic reports that come out more frequently than monthly or quarterly, are rolling over quickly since March and especially since mid-April. Our analysis suggests we are now beginning to cross over a probability level that makes recession our base case for the end of 2022 and into early 2023. As the data roll over, we believe profits are soon to follow. We see earnings for the S&P 500 Index falling modestly in 2023 relative to this year.  At this point, the data indicate a relatively mild and short-lived recession. The best historical comparison for likely recession depth is probably the 1990-1991 recession, roughly a contraction of 1.5% from peak to trough. Our gross domestic product (GDP) projections call for a modest 1.5% growth rate this year followed by a 0.5% contraction in 2023. Inflation is unlikely to fall as quickly as the economy slows in the approach to a recession because of a tight labor market, supply-chain disruptions, and buoyance from rents and other “sticky” components of the Consumer Price Index (CPI). We believe inflation’s slowdown should gain momentum in 2023 with a slowing economy and reduced supply shortages.

A central point of our guidance has been that investment opportunities typically arise throughout an economic cycle, but a recession requires extra patience. Patience has implications for long- and short-term investment horizons. Long-term investors usually diversify for times like these. We recommend an incremental plan to deploy cash over the coming year (or longer) and continue to emphasize quality and defense in an effort to preserve capital. For investors with short-term (tactical, 6-18 months) investment objectives, some may benefit from holding additional cash while others may want to consider shifting away from cyclically oriented to more quality-oriented and defensive assets and expect additional entry points in the coming months.

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