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Volume 11, Edition 37 | December 12 – December 16, 2022

Rethinking Recession Repercussions

Doug Walters, CFA
There is much talk about recession these days. While there are many reasons to be anxious about an economic downturn, your investments need not be one of them.

Contributed by Doug Walters, David Lemire, Max Berkovich, Eh Ka Paw

So, a recession is coming. At least, that is what seems to be the prevailing wisdom of the media these days. It is hard to pick up a paper or watch the news without hearing the dreaded “R” word. But as an investor, be careful how you respond to this barrage.

Investors should take recession talk with a grain of salt. For starters, the media survives by sensationalizing the mundane. Fear sells. Recessions may not be pleasant, but they are a normal part of the economic cycle. They create bargain-hunting opportunities for long-term investors. Those with a shorter time horizon should already be positioned with a risk allocation appropriate for their situation.

A recession may already be priced in. The stock market is down this year in large part due to economic fears. The market is a forecasting mechanism and prices today reflect the collective wisdom of what all investors believe will happen in the future. If a recession is coming, guess what… it is already priced in. Let the recession bargain-hunting begin!

But the collective wisdom of the stock market does not always get it right. Renowned economist Paul Samuelson once said the stock market had predicted nine of the past five recessions. Taking that a step further this past week, Fed Chairman Powell was uncharacteristically candid, saying, “No one knows with any certainty where the economy will be a year or more from now.” Wow! Welcome to the mindset of an evidence-based investor Mr. Chairman.

Evidence-based investors do not base decisions on fruitless predictions of the future. If your investment process requires you to know the future… prepare for disappointment. A better approach is to look for opportunities to bias portfolios for outperformance based on what you know today, not what you think will happen in the future. Factor investing, tactical bargain hunting, opportunistic rebalancing, intelligent diversification, and selective loss harvesting are all in the savvy investor’s toolkit, and none of them require a crystal ball.

1.1%

Average US stock market return during a recession

Since 1929, the average US stock market returns before, during, and after a recession give reason to believe better returns are ahead. Average returns around a recession:

Three months before: +1.1%During: +1.0%One year after: +24.5%Source: Blackrock Student of the Market, August 2022

Headline of the Week

The Fed Strikes Again

The Federal Reserve raised interest rates by an expected 50 bps (0.50%).

The old axiom says that you can’t fight the Fed, meaning if the Fed wants rates higher, then rates will move higher. Over more extended periods of time, the expression normally holds. However, that doesn’t mean the market can’t vigorously debate with the Fed. That seems to be happening as longer-term rates remain below shorter-term rates… the dreaded inverted yield curve. Markets are questioning the Fed’s resolve to keep rates higher for longer. Hopefully, the debate will be resolved amicably with the desired soft landing. No predictions, just preparations.

The Week Ahead

The rate games shift attention to the Far East as Japan and China have central bank meetings next week. The week will end with PCE inflation report as we head into the Holiday shortened week.

Keeping an eye on the “I.”

The preferred inflation gauge for the Federal Reserve has been the Personal Consumption Expenditures Index (PCE), and we will have the November print on Friday.

  • The October core read (excluding the volatile food and energy) was 5% for the year, down from 5.2% in September. Investors should rejoice if we can get it below 5% for November.
  • While the other price index reports have been showing inflation easing, the moderation has been mild, so a more substantial decline is needed for the markets to start pricing in a ¼ of 1% move in February.
  • Retail Sales have started to show cracks, so the Conference Board’s consumer confidence report will also be worthwhile to watch.
  • It has steadily ticked down in the last few reports; this time, a dip below 100 is expected.

More of the Same

Gross Domestic Product (GDP) for the third quarter will have another review in the U.S. and the United Kingdom.

  • No change is expected from previous reports, but a move in either direction will cause volatility.
  • UK GDP contracted by 0.2% in the September quarter, which was blamed on the bank holiday for Queen Elizabeth II’s funeral.

Far East

The Bank of Japan (BOJ) and People’s Bank of China (PBoC) are scheduled to make interest rate decisions on Tuesday.

  • The BOJ is under a little less pressure than other developed market peers as the inflation there is much calmer, though moving up and at an eight-year high.
  • Without the big inflation backdrop, the BOJ is expected to do nothing and keep short rates negative and the 10-year cap at 0%, at least for a while longer.
  • China isn’t expected to make any rate moves; however, pressure is forming to lower rates to fuel the economy.

Let Your Light Shine!

Sunday night is the start of Hannukah. The Jewish Festival of Lights lasts eight nights.

  • For those observing: Happy Hannukah, chag sameach!

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