Strategist claims a U.S. economic downturn would be advantageous for markets

Michael Yoshikami, the founder and CEO of Destination Wealth Management, believes that a U.S. recession could prevent a significant market downturn in the second half of 2023.

In April, U.S. consumer price inflation eased to 4.9% year on year, reaching its lowest annual pace since April 2021. This data from the Labor Department indicates that the Federal Reserve’s efforts to curb inflation are starting to show results.

The headline consumer price index has significantly cooled since its peak above 9% in June 2022, but it still remains well above the Fed’s target of 2%. The core CPI, which excludes volatile food and energy prices, rose by 5.5% annually in April, indicating a resilient economy and a persistently tight labor market.

The Fed has consistently stated its commitment to combating inflation, but there has been disagreement among officials regarding interest rates, as revealed in the minutes from the last Federal Open Market Committee meeting. While Chairman Jerome Powell hinted at a pause in rate hikes, some members believe further tightening may be necessary, while others anticipate a slowdown in growth will eliminate the need for more tightening. Since March 2022, the central bank has raised rates 10 times, totaling 5 percentage points.

Despite market expectations, the market is pricing in rate cuts by the end of the year, with CME Group’s FedWatch tool indicating an almost 35% probability that the target rate will end the year in the 4.75%-5% range. By November 2024, the market is pricing a 24.5% probability of the target rate being cut to the 2.75%-3% range.

In an interview with CNBC’s “Squawk Box Europe,” Yoshikami stated that the only scenario where rate cuts are likely is in the event of a prolonged recession. However, he believes this is unlikely without further policy tightening, as falling oil prices would stimulate economic activity.

Yoshikami also expressed his belief that more companies will guide the market more conservatively in terms of forward earnings, as they anticipate higher borrowing costs and tighter margins. He warned investors to be skeptical of valuations in certain sectors, particularly tech and artificial intelligence, and to consider the potential impact of a recession on the market.

Recent statements from Federal Reserve officials, including St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari, suggest that sticky core inflation may require tighter monetary policy for a longer period and could necessitate further rate hikes this year.

Yoshikami emphasized that cutting rates would be a drastic move despite market expectations. He suggested that policymakers may try to influence market expectations through speeches and public declarations rather than immediate policy action.

Given the uncertain path of monetary policy and the U.S. economy, Yoshikami advised investors to approach valuations in certain market sectors, especially tech and artificial intelligence, with skepticism. He urged investors to thoroughly consider earnings projections and the potential impact of a recession on stock prices.