Recession or soft landing? That’s the big question. Amid the uncertainty framing the investment picture, we explore how to position portfolios.
December 14, 2023
Managing Director, Head of Investment StrategyRBC Europe Limited
The question on everyone’s mind is whether the U.S. economy will enjoy a
soft landing in 2024 or succumb to a recession—with each piece of data
dissected and interpreted according to market participants’ biases. Such
scrutiny stems from the U.S. Federal Reserve’s reliance on “data
dependency,” which leaves markets at the mercy of each data release.
Take the recent data, for example. After U.S. nonfarm payrolls rose by
199,000 in November (consensus expectation: 185,000), most on the Street
agreed that it suggests a very healthy labor market, and hence a strong
economy with a soft landing in sight. Those concerned an economic
contraction may be in the offing focused instead on average hourly
earnings rising at an annual rate of four percent, a level inconsistent
with the Fed’s two percent inflation target. In this line of thinking,
such high wage growth indicates interest rates will have to be maintained
at current levels for longer, which may eventually propel the economy into
In the feature article from our Global Insight 2024 Outlook, RBC Dominion
Securities Inc. Investment Strategist Jim Allworth points out the debate
will not be settled definitively for a while. In fact, it is the Business
Cycle Dating Committee at the National Bureau of Economic Research which
determines the official start date of any recession that arrives. And that
announcement usually comes about a year after a recession has begun.
With economic data volatile—offering contradicting clues at best or being
of poor quality at worst—using a framework to assess the macroeconomic
backdrop can be a useful tool.
We are in the camp of those expecting a mild recession in the U.S. next
year. The combination of high interest rates and restrictive bank lending
standards that is in place today has historically resulted in recessions.
Soft landings, on the other hand, have featured rising interest rates but
no overt tightening of lending standards.
Line chart showing the net percentage of banks which are tightening
credit standards for commercial and industrial loans to large and
small firms using data from the U.S. Federal Reserve’s Senior Loan
Officer Opinion Survey on Bank Lending Practices. A positive
percentage indicates business lending standards are tightening, while
the converse holds true. Since Q3 2022, lending standards have
markedly tightened, peaking in Q3 2023, with some 50 percent of the
banks tightening standards. The percentage has fallen somewhat since,
but more than 33 percent of the banks still have tightened credit
Note: October 2023 Senior Loan Officer Opinion Survey on Bank Lending
Source – Federal Reserve Board, Macrobond, RBC Global Asset
Management, RBC Wealth Management
RBC Global Asset Management Inc. Chief Economist Eric Lascelles concurs,
estimating the probability of a recession at 70 percent over the next 12
Still, that leaves the probability of a soft landing at 30 percent, not an
insignificant level. For our part, we acknowledge that shifts in monetary
and fiscal policy over recent years could mean merely lower growth, as
opposed to a recession.
So, it’s worth looking at episodes of soft landings and observe how the
S&P 500 reacted.
Since the mid-1950s, there have only been three soft landings, admittedly
a small sample: in the 1960s, mid-1980s, and mid-1990s. In each of these
episodes the S&P 500 performed very well, gaining on average more than
Paul Danis, head of asset allocation at RBC Brewin Dolphin, points out
that specific or idiosyncratic circumstances contributed to each of these
rallies. In the 1966 soft landing, the Fed loosened monetary policy very
quickly, fuelling the rally. That resurgence proved short-lived, however,
because the Fed was forced to resume its monetary policy tightening to
rein in inflation which had flared up again, and the stock market duly
Heading into the 1984 episode, the real fed funds rate was over six
percent. The steep decline, to one percent, was instrumental in driving
robust equity returns.
The third soft landing occurred in the mid-1990s, a time of rapid
globalization that both contained inflation and boosted profit margins.
These factors fuelled the longest and strongest rally of all three.
To our mind, the recent rise in nonfarm payrolls suggests a lower chance
of an imminent recession. This opens the road to new highs in equity
markets, in our opinion. The S&P 500 has rallied 14 percent since the
end of October as the Fed paused its rate hikes and the soft landing
narrative gained traction. The rally suggests to us some discounting of
the soft landing scenario, but we think stock markets may have more room
It seems to us the U.S. economy is poised to start the new year on a
strong enough footing to keep S&P 500 earnings growing, although
probably not by as much as the current consensus estimate for 2024 ($245
per share, up 11.4 percent from 2023’s expected $220) would suggest. In
our opinion, any growth in earnings would leave room for share prices to
advance between now and the end of 2024, even if the path for getting
there remains in debate.
We continue to recommend a Market Weight position in global equities as
well as U.S. equities. Our stance takes into account the wide range of
possible outcomes for the U.S. economy: soft landing, average growth, mild
recession, or otherwise.
We believe, however, that investors should consider limiting individual
stock selections to high-quality businesses, or those they would be
content holding through the economic cycle. This means companies with
solid business models, quality management teams, robust cash flow
generation, and strong balance sheets.
In our view, portfolios that have held their value to a
better-than-average degree will be best-equipped to take advantage of the
opportunities that are bound to present themselves when a stronger pace of
economic growth reasserts itself.
RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC.
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