As the old joke goes, economists have successfully predicted 9 of the last 5
recessions—and the stock market probably more. If you have clients worried
about the U.S. sinking into economic quicksand, tell them to turn off the news,
look at the facts and stay disciplined about their long term objectives.
Sure, the markets dropped 10 percent over 5 recent trading days between August
17 and 24. Statistically experts say that qualifies as a “correction” which can
be either healthy or foreboding depending on your point of view. According to Yardeni
Research, there have been almost 30 corrections of 10-plus percent since 1950,
but not always followed by a bear market or economic recession.
We’re not in the financial advisory business, but many of you who are, have assured
us that last week’s market volatility is little more than long overdue waves in
a long stretch of smooth sailing.
Last time we checked, equities were still considered “risk assets,” not
T-Bills, so there are going to be some ups and downs from time to time. “Even
though people are asking themselves if prices are too high, they are slow to
take action to sell,” explained renowned Yale Economics Professor, Robert
Shiller, in
a thoughtful piece in yesterday’s New York Times. But “when prices make a
sudden drop, as they did in recent days, people tend to become fearful, even if
there is a subsequent rebound. They suddenly realize their views might be
shared by other people and start looking for information that might confirm
belief,” added Shiller.
Makes sense. But, as
William Dudley, president of the Federal Reserve Bank of New York opined last
week, “The stock market has to move a
lot—and stay there—to have implications for the U.S. economy.”
Case in point. The Commerce Department said late last week that durable orders
rose a healthy 2 percent in July on top of recent increases in U.S. consumer
confidence and new home sales. That’s a sign the U.S. economy is at least
reasonably healthy and solidly expanding. That tends not to be when recessions
occur, or true market corrections. If nothing else, take a step back and
reflect. Most major market indices right now are pretty much at the same level
they were heading into Labor Day weekend a year ago. Not a substantial return,
but hardly bear market territory.
Millennials' impact on the economy
If that’s not enough, Bill Smead, who manages the Smead Value Fund pointed out Friday that there are 86
million people in this country between the ages of 19 and 37. They don’t own
stocks, they do drive cars, and they want to buy a house. This is nirvana for “them”
said Smead, because they haven’t lost any money in the market, gas prices are
plunging and mortgage rates are likely to remain low. All of which is great for
the economy.
Need more? Last Thursday, the Commerce Department announced that
our nation’s economy expanded at a faster pace than initially thought in the
second quarter as businesses ramped up investment. Gross domestic product, the
broadest sum of goods and services produced across the economy, expanded at a 3.7 percent seasonally adjusted annual rate in the second quarter of 2015, the Commerce Department
said Thursday, up from the initial estimate of 2.3 percent growth.
Still not convinced? Well, the latest figures on business
investment—reflecting spending on construction, equipment, and research and
development—are especially welcome. The category rose at a 3.2 percent pace,
compared with an earlier estimate of a 0.6 percent decline, suggesting a degree
of optimism about future demand. Corporate profits after tax, without inventory
valuation and capital consumption adjustments, rose at a 5.1 percent pace from
the first quarter, the biggest jump in a year. On a year-over-year basis,
corporate profit growth was 7.3 percent. As Business Insider’s Elena Holodny noted
last Tuesday, the risk of markets plunging dramatically again in the short
term are quite low without “certain economic conditions being met.”
John Higgin or Capital Economics noted that "Major declines in the
S&P 500 — that is to say, bear markets in which prices drop by at least 20
percent, which is roughly twice the drop that occurred between 10th and 24th
August — have only tended to occur in, and around, recessions. And we doubt
very much that one of those is around the corner."
Since 1950, the US has seen 9 bear markets and 10
recessions. And almost all of these bear markets have overlapped with the
economic downturns. The one notable exception was October 1987's infamous "Black Monday" when
the Dow plunged a shocking 508 points — or about 22.6 percent. Although
stocks were in a bear market, GDP never went negative.
In light of that, Higgins pointed out that the even
with the recent stock plunge, the US economy is currently looking pretty good.
GDP growth expected to be around 2.3 percent this year, and 2.8 percent in the
next, and policymakers are (still) considering hiking rates this year.
Finally, blogger Ben Carlson, CFA indicated that investing during periods of unrest usually pays off for
investors. Three years out from a recession the
annual returns showed an average annual gain of 11.9 percent, according to
Carlson. Five years out the average annual gain was 12.3 percent. Only one time
since 1957 was the stock market down a year later following a recession, which
occurred during the 2000-2002 bear market.
During
the actual recessions themselves the total returns look much worse as they were
negative, on average (-1.5 percent annually). But this average is made up
of a wide range in results, as stocks have actually risen during 4 out of the
last 9 recessions. And stocks were positive 6 out of the past 9 times in the
year leading up to the start of a recession, dispelling the myth that the stock market always acts as a leading
indicator of economic activity.
Conclusion
Bottom
line, there’s no reason to make any hasty or dramatic changes to your investing
or business expansion plans, and there are bargains to be had if your risk
tolerance and time horizon allows you to explore those opportunities right now.
Even Shiller, whose widely followed CAPE (Cyclically Adjusted Price Earnings)
ratio signals that stock prices are dangerously overpriced admits we’re in a “rare
and anxious “just don’t know” situation.
VCRGD6XDXT3T
TAGS:
economy and stock market correlation, risk of recession, bear market, investor
discipline, business investment, Shiller CAPE, William Dudley, Bill Smead, Ben
Carlson CFA
Posts
