In 2023 and 2024, there was much talk of an impending economic recession in the financial media.   Most of it was just hot air, in my opinion.  The most widely used indicator of future economic activity is still the US Treasury Bond market, but there are many ways to slice and dice this data. Most pundits, in search of a headline to get them clicks in the moment, mangled the analysis trying to sound smart. 

I believe that the best use of this T-bond indicator is found by watching the spread, or difference in yields of longer-term Treasuries, like the 10-year bond, vs shorter term Treasuries, like the 2-year bond.  Their normal relationship has longer bonds offering higher rates, and when this relationship gets backwards, or inverted, it says we have a condition that suggests weak economic activity ahead.  But the devil is in the details as they say.  When this indicator shows that the “spread” or difference in the short and long bond yields begins to narrow, that is when I really pay attention because a recession often begins around 22 months later.  That narrowing began in mid-summer 2023, suggesting that a recession might begin approximately May 2025.  In the spirit of full disclosure, long term indicators like this are not very punctual.  And this just shows us an economic condition, not a trading signal. 

However, with May 2025 just a month away, we find ourselves with a market that has entered a significant decline with many of the major indexes carving double digit losses from the February highs (as of this March 23rd writing).  Was the Inversion of the bond market in 2023 accurate?   

This recession forecast is bolstered by it pointing to the middle of the first year of a president’s term.  The first year of any new presidential term tends to be tough on the stock market.  Markets hate uncertainty!  Investors like to know what the rules are before investing their money, and new administrations, both Democrat and Republican, love to change the rules.  The uncertainty surrounding many of the new policies keeps many buyers in a wait-and-see mode, upsetting the delicate balance between buyers and sellers that a strong stock market depends on.   

I don’t think this will be a big market event like we saw in 2008.  Back then there was a banking crisis afoot which drove the S&P 500 Index down over 56% (data from FastTrack).  Right now, I don’t see any major economic disconnects so I don’t believe that this will be a repeat of 2008. Presidential cycle market weakness normally clears up toward the end of the first presidential year, so this is a time to be patient.  Successful investors are patient investors. 

Washington is working hard to head off a major crisis, as past deficit spending has pushed our national debt to dangerous levels.   If something simply can’t continue, it won’t.  Instead of just giving the issue lip service and continuing to spend as normal, the current administration is trying to handle the problem on their own terms rather than what might happen if printing money by the trillions triggers more inflation. 

One tactic the current administration has chosen is cutting waste and fraud.  We must keep in mind that one person’s waste is another person’s income.  Government spending is an economic driver, so by cutting government spending, part of our economic engine gets starved for fuel.  It is estimated that every $300 billion in government spending equates to 1% of our Gross Domestic Product.  I expect we will see a lot of headlines over the next year or two about how our economy is being hurt by efforts to root out waste, fraud and abuse in government.  There may be truth to this, but it does not reduce the potential value of eliminating government waste.  And my hope is that the economic efficiencies gained will offset the effects of reduced government spending.   

Public sector job cuts reduce inflation.  We have no way of knowing how deep government job cuts will go as the DOGE chainsaw does its work, but the many thousands of government employees that have been laid off, as well as those who will be, will relieve inflationary pressures.  Each dollar saved in payroll is a dollar the government no longer has to borrow to keep us afloat, and that is a good thing. 

Another tactic from Washington is the use of tariffs, sometimes as a bargaining tool, sometimes as an economic lever.  Tariffs can be a fairly benign tool despite what the media would have you believe.  Tariffs do have the potential to raise prices, however history has shown us that inflation remained low when tariffs were implemented during Trump’s first term.  The weakness in our economy caused by lower government spending may provide a disinflationary offset to the inflationary push of tariffs.  Public discussion often overlooks the fact that unlike other taxes, tariffs are voluntary.  One can avoid paying many tariffs by buying American-made goods, which is the goal in imposing tariffs in the first place. 

Consumer confidence is declining hand-in-hand with job insecurity for many government workers, auto loan defaults are at high levels, over one million FHA loans are in default, and student loan borrowers have to make payments for the first time in five years.  Factors such as these tell me we are entering a period where many of us will be spending less. Spending less is what creates economic weakness.  Will it become a recession, or merely a relief of the inflation and overheated stock markets we have had recently?  No one knows for sure. 

Here at Shadowridge, it is our job to foresee these possibilities and position your portfolios appropriately.  Ryan, Christine and I have been adjusting portfolios since February to align with what we think are the most probable outcomes.  We have been harvesting profits, raising cash, moving into stronger market segments and using hedging techniques (buying investments that go up as an index goes down) to stabilize portfolio values.   

I expect the recent volatility in stock prices to persist for a while.  Last year was unusual in its lack of volatility.  We are really just getting back to normal.   This market is certainly a trader’s market, not one that will be kind to buy-and-hold or amateur investors, but one that will favor active management such as we specialize in.  As a Shadowridge client, you are in the right place.