By Vaughn Woods, CFP, MBA
A new bull market is often seen as a sign of economic recovery and renewed confidence. And there are signs of a bottoming market. To illustrate, while inflation fears have intensified since mid-year, bond yields have risen, and the Fed has persistently raised the funds rate. Despite all, the stock market stopped falling. The S&P 500 surged from its June lows, collapsed in August, and is now basically unchanged over the last several months. Cyclical stocks are holding tough and, in the midst of widespread fear of a looming recession, low-quality stocks have done well in this relapse.
Admittedly, the U.S. economy could escape a recession sometime next year if, as many expect, Fed rate hikes diminish after November and December in a stage called a “pause” for the Fed to assess the sum of demand destruction necessary to reduce inflation. Meanwhile, experts point to factors such as the increasing debt levels of developed economies, the declining purchasing power of retirees, and the declining percentage of first-time home buyers that qualify for loans as potential reasons why a recession could or has begun.
We continue to monitor both economic indicators and stock prices for signs of the further discounting which may represent the last leg down in stock prices. The market has already substantially discounted the potential for a recession. But let’s not get ahead of ourselves. Let’s assume a recession is coming and understand how recessions are a natural part of the economic cycle.
Recessions often address the economic imbalances engendered by the preceding expansion, clearing the way for growth to resume. As such, they should not be feared but managed to achieve long-term investment success. The average U.S. recession since 1857 lasted 17 months, while the six recessions since 1980 have lasted less than 10 months on average.
Past performance is no assurance of future results. However, by staying informed from my newsletter about how recessions can impact different industries and asset classes, investors can make more informed decisions about where to allocate their capital during these periods.
Recessions are a common feature of the economic landscape, they’ve grown less frequent and shorter in the modern era. For example, between 1960 and 2007, 122 recessions occurred affecting 21 advanced economies. Recessions prevailed roughly 10% of the time, this according to the International Monetary Fund (IMF). Since the Industrial Revolution, economic growth has been the rule in most countries, and contractions were the recurring exception to that rule. Recessions are the relatively brief corrective phase of the business cycle. Let’s prepare ourselves psychologically for the oncoming recession never forgetting what comes after, the post-recession period economists call the expansion phase. Note the chart below which shows economic expansion periods growing in length.
While it’s admittedly unlikely that a lengthy expansion has begun, since signs that demand destruction are yet to be fully assessed by the Fed’s own actions, it is possible to foresee how investors could begin benefitting within six months. This is the phase in the economic cycle in which stock prices begin rising even as bad news suggests consumer demand is falling, layoffs are causing rising unemployment, and consumer confidence has bottomed into a seemingly permanent state of pessimism. Oh, and worldwide demand destruction is good news.
Finally, while stock and bond investors have penciled in another 185 basis points (1.85 percentage points) of Fed rate hikes over the next twelve months, there are two factors which may cause a pause in further rate hikes. The first is the recognition that the economy is approaching a stall. This may deter further rate hikes by the Fed. The other is if any global or systemic crisis and liquidity issues dog the treasuries markets.
While highly volatile, the S&P 500 has nonetheless managed to trend sideways since June despite frightening inflation reports along the way, increasing predictions for an imminent recession, persistent hawkish talk from the Fed, the 10-year yield rising from 3% to 4.25%, and the Fed funds rate being hiked from 1% to 4% (or at least it will in a couple of weeks). As many good thinkers expect, perhaps the recent resiliency of the stock market will soon succumb to another nasty leg lower in this bear market. Still, it is also possible that the stock market has begun to “change its stripes.” Could stock market strength in the face of ongoing adversity signal that the bear is losing its bite? Not only has the S&P 500 seemingly become more bear-resistant, but its underlying leadership indicates that a market bottom may have already been reached. It’s worth thinking about, as group think is rarely spot on.
Vaughn L. Woods, CFP, MBA
Vaughn Woods Financial Group, Inc.
2226 Avenida De La Playa
La Jolla, CA 92037
Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter are those of Vaughn Woods and Vaughn Woods Financial Group and may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0279.