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When making decisions about the future, it is important to understand it is an exercise in probabilities and not certainties. This is one of the main reasons to diversify investments for both safety and growth. The future world is uncertain, and as a result, it is important to protect against declines as well as participate in growth as markets change. Also, adaptability in the face of a changing environment is essential. Anchoring to old data, while ignoring new data, can lead to decision making that does not correspond well to change.
Under this thought process, it is our opinion that we are now more likely to face a recession in the US. The open question of whether we are in recession already is valid, but to us this is less important. What is important is how we react to a changing environment, and just as important, what we don’t do in these situations.
The reasons we believe a recession is now more likely are based on the following.
- First, recent housing data is beginning to show significant deceleration. Recent numbers show that US home sales are down 20% from a year ago. This is a result of higher mortgage costs and increased prices from this point last year.1 Now, to be certain, we do not believe the housing data is anywhere near the danger levels of the great recession of 2008-2009, but a slowing housing market does create a headwind for many jobs and businesses that are directly or indirectly tied to housing purchases.
- Second, the yield curve and GDP growth are at levels that have been reflective of prior recessions. The yield curve is inverted2, which means short term interest rates are higher than long term rates. While there is no evidence this causes a recession, inverted yield curves have been precursors of past recessions. GDP growth has also contracted over the past two readings3. Historically, two straight quarters of decline in GDP have been a rule of thumb, but not the official marker of a recession.
- Third, the US Federal Reserve commentary has been increasingly focused on reducing the 40-year high levels of inflation in the markets.4 Fed Chairman Jay Powell has stated the Fed will “keep at it until we are confident the job is done”. The main tool used to combat inflation is increasing short term interest rates, which they have already begun but does not appear to be complete as of yet. The unfortunate side effect of using rates to combat inflation is that it tends to reduce, or even contract, growth in the economy.
Again, our view that a recession is now more likely does not make it a certainty. There are plenty of conflicting data points that suggest the US economy could grow even in a time of rising interest rates and slowing housing data. These items include:
- The US is still below 4% unemployment.5 This is indicative of a very strong job environment and wages are still growing. When US consumers have jobs and are getting raises, they tend to spend money, and consumer spending is a critical component of US economic growth.
- Corporate earnings remain relatively healthy. The latest estimates for earnings in the S&P 500 is expected to grow in the mid to high single digit range for both 2022 and 2023.6 When companies are able to grow revenue and show earnings growth, this is a better sign of a growing economy than one in contraction.
A common reaction to recession talk is to assume a violently negative scenario in the markets. Certainly, the last two recessions, 2020 and 2008, have experienced those type of events. However, when examining all recessions going back to 1945, the picture is less bleak. In 7 of the 13 recorded recessions (54%), S&P 500 performance was actually positive during the recessionary period. Also, the average performance of all recessionary periods is +3.68%.7 Further, the US stock markets have already experienced a bear market, with the S&P 500 falling by more than 20% from its high in 2022.8 Could stocks fall further from here? Absolutely. If we begin to fear a more prolonged recession, or a recession that experiences greater than anticipated decline, then stocks may react negatively. However, it is important to understand that markets typically bottom and begin to rebound before the actual recessionary data begins to turn positive.9
As a result of our adjusted view on a potential recession, it is reasonable to wonder what it means for your personal situation. Before taking any action, it is important to understand your current full financial picture. What assets are held in safe money that will protect against further declines in the stock market. On the other side, what assets are held that will grow if markets continue to increase or as we recover? Also, what are the timeframes for different life circumstances and the uses for the assets held? This is why there is never a one-stop answer for one action that fits everyone. Each individual likely has unique circumstances, abilities to tolerate risk, and various time horizons. Understanding actions to take is part of a planning process that incorporates both safety and growth to weather storms of difficult markets but also prosper when markets have high returns.
