Recession will strike and stocks will drop

• Expect the US economy to shrink later this year, and stocks to retreat, Seema Shah says.

• The top strategist expects a mild recession that ends next spring, and AI to shore up equities.

• Shah advises investors to get creative and invest more widely as the market backdrop softens.

The US will slump into recession and stock prices will slide in the months ahead — but the downturn won’t be nearly as dire as many fear, one leading strategist has predicted.

The American economy is likely to shrink slightly in the fourth quarter of this year, then suffer a larger contraction in the first quarter of 2024, Seema Shah said during a recent episode of Bloomberg’s “What Goes Up” podcast.

However, Principal Asset Management’s chief global strategist forecasted an economic recovery starting in the second quarter of next year.

“This is historically a very short recession, and historically a very, very mild recession,” she said.

“I almost wonder if this is even going to feel like a recession,” she continued. “If you look around, are you gonna say, ‘Wow, the US is recession?’ Probably not, because it’s that mild.”

Shah suggested unemployment could rise from 3.7% today to 4.1% by the end of this year, meaning only a small percentage of the US population will lose their jobs and suffer a serious blow to their finances.

But the strategist warned of a blow to corporate earnings from the economic decline, which could hit asset prices. She cautioned there’s likely to be a “pullback” in stocks, and trading might be “very, very choppy” across much of the market over the next six months.

Even so, Shah said the benchmark S&P 500 was unlikely to fall by even 7% to below 4,000 points by the year’s end, given the positive impact of artificial intelligence on company profits.

While stocks normally drop during a recession, “throw in the tech side and actually everything goes completely out the window because the math doesn’t just doesn’t add up,” she said.

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Shah’s recession prediction reflects the Federal Reserve’s ongoing war on inflation. The US central bank has hiked interest rates from nearly zero to upwards of 5% since spring last year, as higher rates tend to dampen upward pressure on prices by encouraging saving over spending and making borrowing more costly.

Principal’s chief strategist said she expects the Fed’s hikes to cool the economy, but laid out several reasons why she doesn’t foresee a harsh, prolonged downturn.

Household savings have held up better than expected in the face of rising prices and steeper debt repayments, and consumers and businesses owe less debt today than in years past, she said.

Moreover, the prevalence of long-term, fixed-rate mortgages in the US has made its economy less sensitive to rate hikes than global peers such as the UK, as many Americans have locked in lower rates and haven’t seen their monthly payments jump yet, she added.

Shah also offered some advice to investors, as she believes they’ll face a tricky mix of lower returns and greater volatility over the next decade.

“You need to be a little bit more exotic, I think, in terms of how you’re thinking about investing,” she said. Investors should consider thinking “outside of the box” instead of sticking to conventional asset classes, she added.

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