A Soft Landing is a Powerfully Positive Force for the Stock Market

Since 1978, during soft landings, the S&P 500 has about a 2.5x better average annualized monthly total return with almost a 2x lower risk of negative monthly total returns!

Investors have recently been pondering whether the Federal Reserve waited too long to ease interest rates and now risk a recession, or if they can still orchestrate a soft landing.   Depending on the economic releases of the day, attitudes on this subject swing back and forth.   A couple disappointing jobs numbers and a panicky-looking 0.5% initial Fed Funds rate cut stoked recession fears, but several weeks of benign weekly unemployment claims, acceptable gains in retail sales and personal income, and continued evidence of moderating inflation have kept soft-landing hopes alive.

A soft landing is a rather squishy concept in economics.  No formal definition per se, but a concept which nonetheless is widely understood by economists and investment managers.   While economic expansions are usually easy to spot, and recessions eventually become obvious, soft landings are much more nuanced and elusive.   A common definition of a soft landing is a cyclical slowdown in economic growth that ends without a period of outright recession.  It is often thought of as a gradual, relatively painless slowdown which is the primary goal of any central bank seeking to raise interest rates just enough to stop an economy from overheating but not enough to cause a severe downturn. 

Without any formal definition, it is difficult to know whether, at any point, the economy is in a soft landing or just a normal part of an ongoing recovery.  And the concept of a soft landing is often so evasive because as economic growth slows, and inflation moderates it looks remarkably similar to a recession.   While the U.S. officially defines both expansions and recessions (usually after the fact), they do not officially define soft landings.   Consequently, it’s difficult to analyze and quantitatively measure how the overall stock market and its component parts perform during a soft landing. 

What follows is an attempt to quantitatively define a soft landing, develop a barometer which highlights when it is force, and use this measure to examine how soft landings have historically treated stock investors.  The indicator utilized will not be found in any economic textbooks nor in the CFA manual.  Nonetheless, it may still prove useful for investors currently wondering if and when the economy will enter a soft landing and how to alter portfolio bets if it does.