Is a US Recession Really Coming Soon?

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Is the US really headed for a recession? A week ago, you probably saw the stock market take a decent dive on fears of an imminent US recession. The media had an absolute field day with this. Forbes jumped on it, as did The Washington Post, CNBC, Al Jazeera, the BBC, and the list goes on. It's a clicky subject; people love negative news, especially when it touches on the topic of a potential US recession. But do they have a point?

Goldman Sachs recently raised the odds of a US recession from 15% to 25%. JP Morgan raised recession probability to 35%, and their CEO, Jamie Dimon, recently stated in an interview that he thinks the probability could now be as high as 40%. As time goes on, these estimates keep getting higher and higher, and with weak jobs data being released in the US a couple of weeks back, unemployment rising, inflation hovering around 3%, and interest rates unlikely to be lowered by a meaningful amount in the near future, could the US actually be one wrong turn away from a recession?

Well, firstly, I want to address the stock market volatility we've been seeing. Nearly every news outlet last week attributed the sharp decline in markets to concerns around an impending US recession, and that's not entirely the case. It is true that the market had a particularly bad day on Monday the 5th. The S&P 500, the index of the 500 largest stocks in America, fell 3%. The tech-heavy NASDAQ fell 3.2%, and the Dow Jones dropped over 1,000 points to finish 2.6% down. But a lot of people were quick to pin this on an increased likelihood of a US recession, and this messaging came after the release of the most recent jobs data.

If you missed it, the Bureau of Labor Statistics noted that in July, just 114,000 jobs were added in the US, which is down substantially from the figures seen in May and June. Looking at the unemployment rate in the US, while it's still quite low, it has slowly been trending up over recent months. So that, combined with cooler but still reasonably persistent inflation and the reality that interest rates will probably stay restricted for quite some time, is causing people to worry about a recession coming soon. But is this really what's moving the markets? Is a potential US recession really affecting the stock market as much as the media are trying to force us to believe?

Well, even looking at that week of the major market turbulence, if you actually look behind the curtain, even on Monday alone, there were two completely different market events that happened last week which probably caused the stock market shakiness. You had the unwinding of the Yen carry trade, which has been covered extensively across YouTube, and you also had the world's best investor, Warren Buffett, dumping huge sums of Apple stock back into the market. After commentary from Buffett earlier in the year saying he's comfortable trimming Apple to hold more cash, seeing him make such a big move likely prompted many investors to reconsider their investments in the high-flying tech stocks.

The news caused Apple to fall around 5%, but this really just highlighted a much bigger trend we've been seeing in the Magnificent Seven. Even over the past month, the reintroduction of volatility in these seven businesses is where we see the big overarching story of what's driving the stock market right now. If we look at the current trends of the S&P 500, we can see since July it took a dive and then recovered.

When we look at the price charts of The Magnificent Seven companies, notice something: since mid-July, these businesses have tanked and then recovered. You can say, "Well, of course these stocks will move up and down as the market does," but it's actually the other way around; these stocks are the market. The Magnificent Seven, even after their big dip and recovery across the past month, still occupy about 30% of the S&P 500. The S&P 500 is more concentrated than it ever has been.

This article I was reading on Seeking Alpha noted that out of the entire upward movement of the S&P 500 this year, one-third of it was down to just these seven businesses appreciating. Seven out of 500 businesses accounted for 30% of the gains. Think about that. Ultimately, what this means is that changes in sentiment in just these seven businesses have an outsized impact on the broader market. The media can talk about an imminent recession, the upcoming election, or even interest rate changes, but ultimately, the bigger mover of the stock market right now is going to be investor sentiment around these seven companies.

The reason this group of stocks is particularly volatile right now—rising and falling so sharply—is because they have been bid up to the moon. The big money has declared that AI is the future and these seven stocks will be the beneficiaries of this technology. What we've seen is insane amounts of money flowing into these stocks, swelling their market capitalizations along the way, north of their current earnings. Investors are making their bets on AI early and then hoping the earnings catch up later.

For example, if we take a look at the valuation ratings from Seeking Alpha, we can see a bit of a theme for where their earnings are at currently. Google gets an F, Amazon gets a D minus, Meta gets an F, Tesla gets an F, Microsoft gets an F, Apple gets an F, and Nvidia gets an F compared to where their profits are today. These businesses have been bid up so high that they need to continue growing flawlessly to satisfy investors, and even one minor slip-up could equate to a much harsher stock adjustment than you'd normally expect.

Take Tesla, for example. They beat revenue estimates but missed on earnings per share estimates, and even though it's common knowledge that the car industry is cyclical and Tesla is having to lower prices while dealing with more Chinese competition, the stock fell 12% post-earnings. They still have a PE ratio of around 56—very, very high. Or what about a company on the other end of the spectrum, Google—posting really solid earnings numbers: revenue up 13% year-on-year, net income up 28% year-on-year, $100 billion of cash on the sidelines, and only $12 billion in long-term debt.

They're doing everything right, but when they posted earnings, somehow they still fell 5%. It was because investors found a teeny tiny missed expectation in their YouTube revenue. This is actually a really interesting stat on Seeking Alpha: you can easily see where the companies beat or miss earnings. Take a look at this: Meta beat estimates on their Q2 earnings; Google beat estimates; Microsoft beat estimates; Apple beat estimates; Nvidia beat on their last earnings in May; Amazon beat on EPS but missed slightly on revenue; Tesla missed on EPS but beat on revenue.

Despite this overall solid earnings performance, after their earnings were released, all of them took a massive dive. They have since recovered, but this choppy movement speaks to the bigger problem causing the US market to bounce around at the current time, and it's exactly what this headline is alluding to. Up until now, the Magnificent Seven could do no wrong; it's been nothing but growth and nothing but hype. But now things are just starting to change. It seems, at least for some, that the shine is starting to wear off on the massively hyped tech stocks, and it's becoming a battle between the outright believers and those that think these stocks are a bit overblown.

This sentiment consensus is leading to a lot more volatility than we have seen. I mean, take the company Warren Buffett sold in Apple. If he thought the business was set for gangbuster growth from their efforts in AI and the valuation was fair, there's no way he'd be selling. But take a look at Apple over the past few years: revenue has stagnated, as has their operating income. Sure, Apple can do tens of billions in share repurchases to goose the numbers, but at the end of the day, investors are expecting more than that at a PE of 33.

As I spoke about in another video recently, the sentiment seems to now be changing. So much so that Bank of America Global researchers are expecting earnings growth in the small cap stocks to start outpacing that of their large cap peers—a trend that was drawing money out of the big tech behemoths and back into the small companies in the market but is now just adding to the volatility in the market.

So while we might see news sites linking the performance of the stock market to a US recession or macroeconomic factors like jobs data or currency fluctuations with the Japanese Yen, the main thing that's really going to dictate the near-term performance of the S&P 500 is really what happens to these seven businesses that collectively hold one-third of its weight. If investors stay excited about AI, the market will likely keep going up. But if AI loses its luster, or if these companies stop posting such strong growth numbers, then you can expect the broader market to fall.

To specifically hone in on the topic of a potential US recession, it's important to remember that while you hear a lot of speculation online, the truth is nobody knows for certain if or when one might come along, and it's pointless to try to make investment decisions based on that information. I mean, the funniest thing is when I started writing this video in the midst of last week's sell-off, all of the articles were talking about how the US is definitely headed for recession. But since I started writing, the crazy thing is the market has almost completely recovered; it's now down only 2% from its all-time high.

What's even funnier is now the news articles are talking about how the US isn't going into recession. Look at this: from last week when we saw articles that Goldman Sachs raised its recession probability to 25%, this week the article is Goldman Sachs lowers its recession probability to 20%. You can't make this stuff up—one week later and all is well again. The value of retail sales increased in July by the most since early 2023, and government figures showed the fewest applications for unemployment benefits last week since early July.

It just goes to show that you really cannot buy into this recession chatter. One week it's doom and gloom, and the next it's clear skies. Honestly, to keep myself grounded, I always like to think about what the world's best investors would say in these sorts of scenarios—the Warren Buffets, or the Charlie Mungers, or the Benjamin Grahams.

A great quote about the stock market that comes from Ben Graham is, "In the short run, the stock market is a voting machine, but in the long run, it is a weighing machine." What this means is that over a period of weeks or months, or sometimes even years, the stock market's movements are really just a result of what people think. If they're excited, stock prices rise; if they're pessimistic, stock prices fall, and you cannot control that at all.

So the only way around this as an investor is to think long-term. In the long run, stock prices ultimately reflect the long-term business performance, right? There was a lot of pessimism about Amazon during the tech bubble that drove the stock down, but in the long run, the stock performance is a result of what that business has been able to achieve over time.

I think it's important to detach what you're seeing here in the media on the day-to-day and think along those lines. At the end of the day, Google stock will go up and down based on what investors think about AI, and it will also go up and down based on whether or not the US goes into recession. But right now, Google produces $5.50 per year in free cash flow for each one of its shares, and over the long run, if the business stays healthy and that number continues to trend up, the long-term trend of the stock will also be up.

You can say that for any business in your stock portfolio, and I think it's important to remember that in times like these. I also wanted to again thank Seeking Alpha for sponsoring this video. As I'm sure you could tell throughout the video, Seeking Alpha Premium is one of the few resources I use on the daily when looking into businesses, so I'm very happy to partner with them.

If you want to try them out for yourself, remember you can get seven days for free by using the link in the pinned comment, and if you sign up for an annual subscription, you'll also get $25 off through my link. It's a great partnership I've got going with them; I definitely recommend checking them out.

But with that said, thanks very much for watching, guys, and I'll see you all in the next video.