posted on March 4th 2016 in Market Commentary & Newsletters with 0 Comments /

Recession or no recession

Recently, the focus for investors has been all over the map:

  1. Oil prices
  2. Corporate earnings
  3. The global economy
  4. China’s economy
  5. China’s currency (the yuan)
  6. Anxieties about banks (especially in Europe)
  7. The Federal Reserve’s next move
  8. Global central banks that may be running out of ammunition to counter economic weakness
  9. Emerging market debt
  10. “Brexit,” — the possibility Britain will exit the European Union this summer
  11. Political uncertainty in the U.S.

It’s not an all-inclusive list, however, it adds up to a whole host of worries that investors are having to grapple with in the short term.

Yet, U.S. stocks in February ended mixed as oil prices ticked higher and the economic data improved.

Notably, the more positive economic reports come at a time when the global outlook is tepid at best. But it highlights that the driver of U.S. economic activity isn’t coming from overseas. Instead, it is homegrown.

Table 1: Key index returns

MTD % 2015 % 3-year* %
Dow Jones Industrial Average +0.30 -5.21 +5.53
NASDAQ Composite -1.21 -8.98 +12.98
S&P 500 Index -0.41 -5.47 +8.45
Russell 2000 Index -0.14 -8.98 +4.30
MSCI World ex-USA** -1.65 -8.47 -2.82
MSCI Emerging Markets** -0.28 -6.78 -11.13

Source: Wall Street Journal, MSCI.com , MTD returns: January 29, 2016—February 29, 2016
Annual Returns – December 31, 2015–February 29, 2016, *Annualized,  **USD


Let’s grow the list by one more item: U.S. recession worries

If you listen to the pundits of doom and gloom, we’re going to enter a recession this year that will take stocks to new lows.

First,  let’s state the obvious and then provide some examples in a moment. Economic forecasters do a pretty lousy job of calling turning points in an economic expansion.

Thinks of it this way: Pile a bunch of seasoned sport analysts into a room and ask them who’s going to come out on top of an important football or basketball game.

While they will offer a thoughtful analysis of each team’s strengths and weakness, and may even agree on many points, they will draw different conclusions as to the outcome. And their predictions for the final score–well, those will vary widely.

The same holds true for economists.

Take former Fed Chief Alan Greenspan, who headed up the Federal Reserve from 1987 – 2006. In March 2007, Greenspan said there was a “one-third probability” a recession would take hold in the U.S. that year.

By December, the U.S. would enter what would eventually be called the “Great Recession”. So much for Dr. Greenspan’s complex forecasting models.

His successor, Dr. Ben Bernanke, had just told Congress the economy might strengthen.

“Overall, the U.S. economy seems likely to expand at a moderate pace this year (2007) and next (2008), with growth strengthening somewhat as the drag from housing diminishes (Semiannual Monetary Policy Report to the Congress February 2007).”

Wow. In hindsight, his comment on housing reveals he was completely oblivious to the economic problems the country was about to face.

Yes, the best and brightest are sometimes humbled by circumstances outside their control.

 

Why does all of this matter?

There has been increased talk that the U.S. economy may enter a recession later in the year and recessions depress stocks.

Some of the recession chatter has to do with what’s happening globally and some has to do with what’s happening to oil prices.

We’ve pointed out in prior commentaries that the U.S. economy isn’t dependent on China.

About that drop in oil prices – global supply has outstripped global demand, which is still growing, according to data from the Energy Information Administration. In other words, it’s a problem of too much supply, not falling demand, which would be signaling a global recession.

Yet, in no way is the recession chatter the consensus view. But it does add some uncertainty to the mix, and it has pushed out forecasts for a recovery in corporate profits.

For example, at the end of November, Q3 and Q4 earnings were forecast to be slightly negative before turning higher in the first quarter of 2016.

Enter another slide in oil prices and a sharp downward ratcheting of estimates for energy companies, and a return to growth in profits isn’t expected until Q3 of 2016.

If economic growth stalls later in the year, it would put added pressure on corporate profits and further delay any earnings recovery because historically corporate earnings have been a byproduct of what’s happening in the economy.

 

Perspective

Economic forecasting is an inexact science. But we will give you an opinion. We will descend into another recession. That’s right. It may be in 2016 or 2017 or 2018 or beyond. But an eventual recession (and subsequent recovery) in a free market economy is to be expected.

And when it happens, stocks will probably lose value since bear markets closely correlate with recessions.

While the individual plans we recommend mitigate some of the risks, they do not eliminate risks.

Given the volatility that strikes the market from time to time, we encourage you to avoid watching the daily gyrations in stocks.

Warren Buffett offers another valuable piece of insight –

“Games are won by players who focus on the playing field—not by those whose eyes are glued   

 to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give

 it a try on weekdays”

That brings us to the next point. “Markets over a long period of time are going to go up,” Buffett said in a late February interview on CNBC. His advice is an excellent foundation for those with a long-term perspective. While none of us enjoy seeing the market decline, let’s remember that it never goes up in a straight line.

Besides, if you are young, daily or weekly monitoring only lifts you up or brings you down. Does it really matter what today’s value is when you won’t retire until 2035 or 2040? It doesn’t when you have a disciplined investment plan in place.

But we recognize that many of you aren’t right out of college but are nearing or in retirement.

More conservative portfolios have much lower allocation to stocks.

By definition, they are more conservative in nature, which limits the downside in turbulent markets. Still, we continue to recommend some exposure to stocks, which allows you to capture some of the upside when stocks rise.

 

Bottom line

There is plenty of uncertainty in the world (hasn’t that always been the case?) and we are bombarded with bad news daily, but we believe this comment from Buffett’s just-released 2015 annual letter to Berkshire Hathaway shareholders reflects our sentiment:

“For 240 years it’s been a terrible mistake to bet against America, and now is no time to start.

 America’s golden goose of commerce and innovation will continue to lay more and larger eggs.  

 America’s social security promises will be honored and perhaps made more generous. And, yes,

 America’s kids will live far better than their parents did.”

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