Maybe a Recession Isn’t Headed Our Way, Says Pantheon

As the market blips up for a change, the firm’s top economist sees dwindling profit margins as saving the day.

Amid all the economic gloom and doom, and a brutal market drop, stock investors are permitting themselves some breathing room, with a 0.95% increase in the S&P 500 Thursday. This follows a small fall Wednesday (0.13%) and a nice pop (2.45%) on Tuesday. True, this could be a short-lived bear market rally.


Yet the uptick prompts the question: Could there indeed be some actual hope that no recession will blight our existence in the coming 12 months?


To Ian Shepherdson, chief economist at Pantheon Macroeconomics, a virtuous chain of events is possible, where the Federal Reserve whips inflation now and averts a recession. In a research note, Shepherdson argued that compressed profit margins could be an integral part of that positive progression.


Rapidly expanding margins were a feature of the buoyant pandemic economic growth that we enjoyed until recently. Pantheon estimates that two percentage points of the core Personal Consumption Expenditures index, the Fed’s favorite inflation gauge, stems from strong margins. The core PCE (that is, with energy and food stripped out) was 4.9% recently.


Lately, Shepherdson noted, the core Producer Price Index is still rising, but its trade services component (which measures immediate demand) has descended. Trade services have “abruptly stopped rising, because the force which propelled it upwards—the pandemic inventory crunch—is now over, and retail and wholesale inventory in most sectors is now approaching its pre-Covid level.”


His expected result: downward pressure on prices as profits slump. Already, various forecasters are lowering expected corporate earnings for the rest of this year. But bounteous cash on household and company balance sheets should cushion the economic impact of lower profits, the economist reasoned.


The most commonly followed inflation metric, the Consumer Price Index, has done nothing but climb, which has fed people’s growing unease about the economy. It rose to an annual 8.6% in May, up from 8.3% the month before.


The PCE, though, has actually edged down slightly, to 6.3% in April from 6.6% in March. Core PCE had a similar small dip, to 4.9% in April from 5.2%. Shepherdson projected that the May core PCE, due out June 30, will continue to show a down-trend, to 4.7%. Recent drops in oil prices lend that notion support.