Is there a Recession coming…or is it already here and we just don’t know it yet?
There has been a lot of chatter recently about whether we’re headed for a recession or not.
Recently we’ve heard some of the Big Whigs – like Jamie Dimon of JPMorgan Chase (JPM) and Goldman Sachs (GS) President John Waldron – issue warnings about the economy. Former Federal Reserve Chairman, Janet Yellen also warned about the danger of rising inflation.
At a financial conference in New York on June 1st, Dimon said, “You know, I said there’s storm clouds but I’m going to change it … it’s a hurricane. While conditions seem “fine” at the moment, nobody knows if the hurricane is “a minor one or Superstorm Sandy,” he added.
The next day, President of Goldman Sachs, John Waldron told a banking conference, “This is among, if not the most complex, dynamic environment I’ve ever seen in my career. We’ve obviously been through lots of cycles, but the confluence of the number of shocks to the system, to me is unprecedented.”
In an interview with CNN, Janet Yellen was shown previous remarks she’d made last year where she indicated there would only be a “small risk” of inflation, and that it would be “manageable.”
In response, Yellen said, “Well, look, I think I was wrong then about the path that inflation would take.”
Yellen’s admission was stunning. You rarely – dare I say, never – hear anyone in a position of such power admit they were wrong.
According to the latest data, inflation has climbed 8.6 percent year-over-year — near a 40-year high. The Federal Reserve has already raised its key interest rate twice this year, and has signaled it intends to do so again at its meetings this month and in July, and may be required to raise the rate again at its August and September meetings.
The Fed’s current “target federal Funds rate” is 0.75% to 1.0%, already a sharp increase from the zero percent target rate it held for several years. If they raise the target rate by just 25 basis points in each of the next four meetings, rates will be a full one percent higher (1.75% to 2.0%) by September.
That is very important not only for the equity markets – since higher rates provide a non-equity alternative investment option for very conservative individual and institutional investors, but the valuation level of the broad market – especially the stocks of companies needing to raise capital to sustain operations, will be negatively impacted.
The technical definition of a recession is two consecutive quarters of negative GDP growth. We already know the 1st quarter of 2022 saw a decline of 1.5% in the GDP rate. With early warnings of slower sales and lower profits from economic staples like Target and Wal-Mart, many analysts are predicting the second quarter GDP could also come in negative – confirming the economy is already in a recession.
There are a few early signs in the equity market that confirm that possibility. Historically certain market sectors have been an “early warning” of a slowdown coming to the broad economy. The financial sector as well as the small cap stocks both tend to be sensitive to changes in the underlying economy and can be early warning indicators of impending slowdowns. The charts of both sectors peaked several months prior to the broad markets and continue to be in down trends.
The end of this month we’ll get the 3rd revision to the 1st quarter GDP and then we’ll see if the number is still negative – which I expect will be the case. But we won’t know officially for a while if the economy is actually in recession since the “advance estimate” (read – not very accurate) 2nd quarter GDP report comes out at the end of July and the “preliminary” (read – a little more accurate but still open to wide revisions) doesn’t come out until the end of August.
The responsibility of declaring when an “official” recession begins and ends falls to The National Bureau of Economic Research (NBER). More specifically, it is the Business Cycle Dating Committee within the NBER that decides. They are historically very slow in making that determination. At times, it’s been 18 months, or more, after the recession is over before they proclaim the “official” start and end dates. Obviously, not very helpful in real time.
So, if we are in (or about to enter) a recession, what should you do? If your portfolio is too heavy with equities, you might want to use counter trend rallies to look for opportunities to reduce that allocation. Determining whether it’s “too heavy” in equities is subjective and should take into account factors like, time horizon, risk tolerance, emotional makeup, etc. and is probably best examined with the assistance of a financial planner. If you don’t have a plan, now is a good time to get one.
If you feel your portfolio allocation is suited to those personal variables, you know you own high quality assets for the long term, and understand that the current economic and investment market environment won’t last forever, it’s probably best to hunker down and weather the storm. And if you have the fortitude, you might even consider using the market volatility as an opportunity and look for attractive values in high quality companies for long term growth.
As famed value investor, Shelby Cullom Davis once quipped, “You make most of your money in a bear market, you just don’t realize it at the time.”