Fear that a market-punishing recession is right around the corner seems ubiquitous.
Fear that a market-punishing recession is right around the corner seems ubiquitous. Headlines, cable news chyrons, social media, talking heads, investment analysts and politicians solemnly convey the following composite message:
Monetary actions by the Federal Reserve Board will plunge the nation into recession this year or early next. This fate is confirmed in blinking neon by the trends in yields of Treasury bonds of different maturities, known as the yield curve. The recession will push the already declining stock market much lower, savaging returns of millions of Americans investing for retirement. Inflation, at a 40-year high, is wrecking our economy and will continue indefinitely. The war in Ukraine will grind the market down even further.
This picture of financial conditions is the bleakest since the financial crisis of 2008 (an actual crisis). Astonishingly, these prognosticators seem quite certain about something that is impossible to predict with certainty. At the very least, some of their predictions lack nuance and qualification. At the worst, they misguidedly rely on analysis that is flat-out wrong, hyped or distorted.
Sure, economists cover themselves with a lot of if-then statements. But the general tone of the media and some renowned investors these days is that a recession is coming soon — no question about it — and it will push the market far below current levels. The message is clear: Financial apocalypse is at our doorstep.
Sure, a recession is coming. Recessions are like rain: One is always coming. The question is: When? Doomsayers seem impervious to various data indicating that a recession before 2024 (if even then) is unlikely. They dismiss various indications that regardless of what happens with the economy, the market will not necessarily tank. But not all bear markets occur with recessions and not all bull markets occur with great economies.
Here are some points that challenge the basis for the current hysteria.
The obsession with the direction of Treasury-yield curves is based partly on error, partly on assumption. National media, always looking for simplicity, obsessively monitor the slope of the curve of yields of the two-year and 10-year Treasury bills, as if this is a sure-fire recession indicator. They cover the flattening of this curve as though it were the horrifying descent of the suspended swinging blade in Edgar Allan Poe’s “The Pit and the Pendulum,” threatening to disembowel the economy.
Unfortunately, they are looking at the wrong curve. The more predictive curve is the three-month/10-year, which is currently steepening, suggesting no approaching recession. The inferiority of the two-year/10-year curve as a recession indicator is a matter of historical record. This was clearly demonstrated again in 2018: After an angst-filled summer that year with this curve flattening, no recession ensued. Regardless, recession forecasting should rely on myriad data, not just Treasury-yield curves in isolation.
On the occasions when recessions do follow the flattening of Treasury-yield curves, on average they have historically occurred about 17 months later — and after a 14% gain in the S&P 500. People who are liquidating stocks now to sit out a recession may end up ruing that decision even before a recession begins.
In late April, the government reported the economy contracted in the first quarter by 1.4%, mostly due to inventory adjustments. At nearly the same time, many economic indicators released certainly did not point to a recession. Durable goods orders, personal consumption, unemployment, consumer confidence expectations and auto sales orders all pointed to a strong economy. The economy is solid, but when Fed Chairman Jerome Powell rattles off a litany of statistics demonstrating this at news conferences, no one seems to care. Never mind that jobs are plentiful and many households are in good shape, with low debt and high savings — and a collective excess of $2 trillion accumulated during pandemic quarantining, just waiting to be spent on summer vacations, year-round travel and dining out. Increasing travel and hospitality industry revenues show that the floodgates on this spending have opened.
Historically high inflation is spurring interest rate increases, but for most people this is not the albatross it is made out to be. For one thing, inflation is expected to diminish late this year or early next as supply chain bottlenecks ease and the current labor shortage abates. For another, those harping on inflation like to cite rising fuel costs, although the average American household spends only about 12% of its budget on food and energy combined. So current inflation has a relatively small impact on these people. But that has not stopped rising gas prices from becoming part of the current gloom-and-doom quotient.
Financial media are laser-focused on Fed watching, on the assumption that its monetary policy changes to fight inflation — interest rate increases and paring the balance sheet of purchased debt — will bring on recession. Although extremely difficult, the Fed’s task is not impossible. Even if the Fed’s actions do trigger recession, it probably will not be anything like the Great Recession of 2007 to 2009, which was almost a depression. If, as widely expected, the Fed incrementally increases the Fed funds rate to 2.75% or 3% this year, this will still be a low level historically. Companies will still be able to borrow money cheaply to finance research and development and propel growth. One reason the Fed’s actions to raise rates and reduce its balance sheet are so widely viewed as negative, says Randall Kroszner, an economics professor at the University of Chicago and former Fed governor, is that the Fed “hasn’t taken away the (stimulus) punchbowl in 25 years. Not many people in the markets have seen this, so it’s a tricky thing politically.”
Even with a substantial bounce from current levels, the overall market will still post a much lower return this year than last — perhaps low single digits. But you just cannot get 20%-plus every year, as we did in 2021. The market is characteristically up and down but, over long periods, nearly always up on average. That is the rationale for long-term investing in a nutshell.
What makes projections of much lower returns this year hard for many to accept is their mistaken belief that we have had a continuous bull market since 2009. This is not the case. We had a short bear market in late 2018/early 2019, and starting in March 2020 there was a brief bear market along with a brief recession from the impacts of pandemic lockdowns. So far this year, a lot of air has already come out of much of the market. The average S&P 500 stock has already declined more than 20% from its 52-week high, a sort of rolling bear market. In fearing a bear market, many people are fearing much of what has already happened.
For good measure, crisis predictors like to end their litany of negatives by mentioning the war in Ukraine. Although the war is profoundly unfortunate, with many civilian lives lost, it is not depressing stock values much, so it would be a mistake to sell stocks just because of the war. Although wars around the world do not usually drive the U.S. market down, investing toward the end of wars is usually a good move because the cessation of hostilities is often an upward catalyst. There may be some buying opportunities as the Ukraine war concludes. Of course, that may not be for months or even years.
So powerful is the current sense of doom that investor sentiment stemming from it may be pushing down the market a little in a bit of a fait accompli. To the extent that this is happening, when the market eventually rises it could spring back even more after these fears diminish. Likely pushing it up from there would be existing long-term forces, including the digital revolution, which has not only driven the growth of tech stocks in recent decades but the overall market as well.
Dave S. Gilreath, CFP, is a 40-year veteran of the financial services industry. He is a partner and chief investment officer of Sheaff Brock Investment Advisors LLC, a portfolio management company for individual investors, and Innovative Portfolios LLC, an institutional money management firm. Based in Indianapolis, the firms manage nearly $1.4 billion in assets nationwide.