Inflation-Recession- Lime in Coconut

“Put The Lime in The Coconut and Drink It All Up”
 – Baha Men(1)

Do you remember the song Put the lime in the coconut? It was originally released in 1972 by Harry Nilsson and redone by the Baha Men. The narrative of the song presents a woman who had a stomachache late in the evening, and she called her doctor. He didn't want to see her, so he told her to put the lime in the coconut and drink it all up. You may be wondering what this has to do with the stock market.

Before I dive into more details about the lime in the coconut miracle fix. I wanted to mention something I saw a few weeks ago on CNBC. It stated that 81% of Americans believe the U.S. will experience a recession within this year. (2) I was shocked because normally they go out and poll 100 different economists and come back out with all these realms of data. Their findings would be very inclusive because they would straddle the fence. I believe this poll done by asking the average American is spot on because many of them are driving by the gas station wondering what gas is going to cost this afternoon. They're going to Publix or Walmart for their groceries, wondering if they're going to spend $200-300?

People have been priced out of home buying because the average house has gone up 20-25% in the last year. And if they can't afford to buy a home, their rent has gone up 20%.

Inflation is Running Hot, Here Comes the Fed

So, Fed Chairman Powell is now going to crush inflation without crashing the economy. In Fed lingo, this means engineering a soft landing. He's going to put the lime in the coconut by raising interest rates. His goal is to shut off demand, which should cool inflation very quickly. It will be very interesting to see if he's able to engineer a soft landing.

For example, if you bought a home a year or so ago, I believe the average house price was about $350-370,000. Your mortgage rate was 2.95%. Fast-forwarding to today, the average home price is $440,000 and your mortgage rate is now 5.4%. So now you're going to spend almost two percent more on an interest payment on a higher purchase, which equates to serious money.

Chairman Powell’s goal is to raise interest rates, which will shut off demand and maneuver to a perfect landing. To put this in a simple context, the American public will now say, I'm just not going to pay that, whether they're looking to buy a home, a car, or a new computer system.

Is the Stock Market a Leading Indicator?

Yes, it is my belief that the stock market as a whole is a leading indicator. Think back to our last recession, which was just two short years ago in year 2020, except the last two years have been anything but short. They seem more like two long years. If you can recall, the market had started going down in the first couple of months of 2020, and then finally, we had the pandemic and pandemic-induced recession. Now, that recession was very short-lived. Even though the market had dropped 25-30% in just a couple of months, by the end of the year, the stock market had not only recovered the losses, but the S&P had a pretty good return of 18%.(3)

Short Recession

I believe this will be a short recession because it's a Fed-induced recession. Once they see demand drop, inflation should move down rather quickly, and they can stop raising the rates. While they can't turn this big economy around overnight, they can certainly point it in the right direction. New home sales dropped in March by about 9% from the prior year. I was talking to a banker the other day, and he had said they had started laying off mortgage brokers. I was also talking to a boat salesman, and he said up to the last month or two, you couldn't get any inventory, and now there's nobody in the showroom.

So maybe the higher interest rates have already taken effect. Furthermore, I believe a huge factor is consumer sentiment, and it is way down. And that's understandable. By seeing all these costs go up, people just are making up their minds, and they're just not going to buy that item. Obviously, they must pay for certain things, but nobody's forcing them to spend money on discretionary/luxury items.