Investors needn’t live in fear of potential recession
Downturns inevitable but infrequent; most have been short-livedJune 16th, 2022
“The stock market has predicted nine of the last five recessions.”
—Paul Samuelson, Keynesian economist
Regarding the realities of recessions, while they are inevitable, they aren’t something investors need live in perpetual fear of.
Two big reasons not to be afraid: Recessions are infrequent and usually short, and with the right portfolio design, they can be safely navigated.
We share that not to make a prediction around the next recession ourselves, which, like trying to predict markets, has been shown to be a foolish endeavor, but rather to at least present another side to the overwhelmingly negative sentiment you’ve likely been bombarded with.
It is also noteworthy that even if a recession were to be on the horizon, the damage to markets may already have occurred in advance, and there isn’t much to “trade” around that news.
When evaluating the market and economy it is more often about relative rates of change, which, in many cases aren’t currently positive, as opposed to just absolute levels, which aren’t all that bad today. However, that truth must also be applied while noting the context of market expectations which today are incredibly bearish/recessionary.
Recent numbers aren’t as good as we’ve seen in the past few years, which would normally be a problem. However, in an environment with such negative expectations, they are the reason the market appears to be finding a floor, and they could be the catalyst to push higher in the months ahead. The fact that such a move would shock most market participants only adds to my “suspicions” that this may be the path forward.
A commentator I respect, Lawrence Fuller, came out with the following key developments to keep in mind regarding recent S&P Global Flash U.S. Composite Purchase Managers Index data—a key metric to watch.
Fuller notes, “The latest survey of purchasing managers in the manufacturing and service sectors from S&P Global confirms that the slowdown is underway but still not falling below trend. The mid-month Flash survey resulted in a decline in the index from a very strong 56.0 in April to 53.8 in May, which was a four-month low. Readings above 50.0 indicate expansion, and this one was still indicative of a healthy level of growth.”
Chris Williamson, the chief business economist at S&P Global, says that survey results, “remain indicative of the economy growing at an annualized rate of 2%, which is also supporting stronger payroll growth.”
Brian Wesbury, chief economist for First Trust LP, commented on the latest manufacturing data by saying, “The manufacturing sector continued to expand in May, and at a slightly faster pace, with 15 of 18 industries reporting growth. The best news … was that the two most forward-looking indices, new orders and production, posted gains after two months in a row of declines. Moreover, both indices are above 50, signaling growth.”
The Flash PMI indicates growth remained resilient in May, as lackluster manufacturing prints were offset by a strong service’s showing. Compared with April, the headline prints did cool a bit, but nonetheless remained expansionary.
The U.S. headline composite index for May came in at 53.8, compared with 56.0 in April; the Eurozone at 54.9, compared with 55.8; the U.K. at 51., compared with 58.2; and Japan at 51.4 compared with 51.1.
You can always cherry pick a data point to prove a point, and the bears are finding some doozies these days to focus on. But a more honest look at the overall health is broad data points, which suggest that while wounded, the economy is once again proving resilient and might even be beginning to show signs of renewed life.
While you may not know it from listening to many of their public pronouncements or earnings calls, where they are somewhat dour, likely in an effort to set a low bar to clear from future earnings reports, their actions when it comes to their own portfolios suggest they are much more optimistic about the future than they are telling you.
A second insight from Lawrence Fuller points out “corporate insiders, who know a thing or two about the economy and their businesses, are scooping up shares of their own stocks like there is a fire sale. … Insiders have not been this aggressive since the pandemic lows of 2020 and December of 2018.”
As the adage goes: Watch what people do, not what they say. Corporate CEOs and insiders aren’t selling; they’re buying.
Recency bias is one of the hardest things to overcome as an investor. When the market is dropping, it is natural to feel like it will never end, and with that type of a belief, of course, people often conclude that they should bail out.
The reality, counterintuitive as it may seem, is that markets bottom on bad news, not the start of good news. A drop of 20% in markets, doesn’t increase the odds of another 20% decline but rather decreases it.
After a 20% decline the more common path forward is higher, not lower. And, following the start of a bear market, it’s the one-year average that is really staggering with an average return of 24%.
Will such history play out again? Of course, no one knows for sure. But Goldman Sachs’ current market outlook states, “Even if (a recession) were to occur, we would expect it to be technical in nature, not cyclical. Financial imbalances, a key driver of recent recessions, are broadly absent today. The private sector—the banking system, businesses, and consumers—is well-positioned to absorb a more challenging growth and inflation mix given sustained balance sheet strength and excess liquidity, lessening potential effects in a downturn. Consequently, any drag on growth would likely be modest.”
Tim Mitrovich is the CEO of Ten Capital Wealth Advisors LLC, in Spokane. He can be reached at 509.325.2003.