Recession Risks: Consumer Confidence and the “Wealth Effect”

The Federal Reserve raised interest rates another quarter point this month, though signaled that an end could be in sight as they keep an eye on banking sector turmoil. That turmoil could have spillover effects however, exacerbating many of the risk factors for recession as consumer confidence and spending drop and potentially leading to further market decline and dislocations that managed futures strategies could offer non-correlated diversification for.

Banking sector stress in the wake of the collapse of Silicon Valley Bank and Signature, and the ongoing uncertainty surrounding First Republic as well as Credit Suisse’s woes overseas have dealt a serious blow to confidence in the sector.

“The bank problems are probably making a lot of people think twice,” Diana Furchtgott-Roth, an economics professor at George Washington University and former chief economist at the U.S. Department of Labor, told CNBC.

Furchgott-Roth underscored the role of the “wealth effect” looking ahead. When people feel less financially stable and confident, they spend less. This in turn leads to slowing retail sales and other consumer goods, which in turn leads to a market reaction that affects consumers.

The Consumer Confidence Index from the Conference Board dropped to 102.9 as of the end of February, the second consecutive decline, while the Expectations Index which measures the short-term outlook for business, income, and labor markets fell to 69.7 — levels below 80 historically signaled a recession in the next 12 months. The Expectations Index has been below 80 in 11 of the last 12 months.

Image source: The Conference Board

Add into the mix rising rates alongside falling income (when adjusted for inflation) and bank tightening that will happen in the wake of the current stress in the banking sector leading to reduced lending to consumers and it puts a cash crunch on households still contending with high inflation and reduced purchasing power. It’s a feedback loop that could further exacerbate recession odds this year as even wealthier consumers feel the squeeze.

“It’s not how many dollar bills you have, it’s what you can buy with them,” Tomas Philipson, an economist at the University of Chicago and former chair of the White House Council of Economic Advisers, told CNBC.

Play Increasing Recession Risks With Managed Futures

Under the Fed hiking regime of the last year, bonds and equities have moved in tandem, both underperforming in portfolios. Banking turmoil has led to sharp declines in bond yields in the last week, and recession risks will pose several challenges for equities, creating a further challenge for traditional portfolios.

In a recent webcast hosted on the VettaFi platform, “The Correlation Conundrum: How to Invest When Diversification No Longer Works”, over 300 attendees were asked what their response to the correlation conundrum of equities and bonds has been. 69.3% of respondents answered overwhelmingly that they seek solutions with lower correlations.

The iMGP DBi Managed Futures Strategy ETF (DBMF) allows for the diversification of portfolios across asset classes uncorrelated to traditional equities or bonds. It is an actively managed fund that uses long and short positions within the futures market on several asset classes: domestic equities, fixed income, currencies, and commodities (via its Cayman Islands subsidiary).

The fund’s position within domestically managed futures and forward contracts is determined by the Dynamic Beta Engine, which analyzes the trailing 60-day performance of CTA hedge funds and then determines a portfolio of liquid contracts that would mimic the hedge funds’ averaged performance (not the positions).

DBMF is currently down about -9.75% YTD, providing a buying opportunity for advisors and investors looking to add the non-correlated opportunities that managed futures can provide. The fund is currently long 1-year Treasuries, the euro, MSCI EAFE, and gold, and is short all of its other holdings which include crude oil, the yen, emerging markets, and various Treasuries.

DBMF has management fees of 0.85%.

For more news, information, and analysis, visit the Managed Futures Channel.