Just about everybody I know is bearish. Money managers, clients, business owners, and others are all confident that a recession is inevitable.
And who can blame them? I think they are right.
This recession, unlike most others, is undoubtedly one of our own design, and I argue that this could’ve been largely avoided. We printed $6T in new money during the COVID-lockdown era (Feb 2020 – Dec 2021), a 39% increase in our money base. Of course, there would be a price to be paid. And that price is inflation.
So, this begs the question – where do we stand now? Are we currently in a recession? This is an excellent question because while there is an official definition, there is no concise way to determine when a recession begins.
Many define a recession as two consecutive quarters of negative GDP growth, which we have already encountered in Q1 and Q2 of 2022. This definition, however, is not official and not comprehensive enough.
The NBER (National Bureau of Economic Research) has the privilege of officially deciding when a recession begins and ends. They define a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
A recession must be a pronounced, pervasive, and persistent downturn in production, jobs, income, and spending.
We see a downturn in most of these segments, but not all.
The job market is still reasonably strong. And for this reason, we do not think we are in a recession yet.
But this is likely to change soon.
Expect Layoffs Soon
According to the Labor Market Growth Index, a weighted composite of six labor-market measurements, the trend is negative and likely to hit recession levels soon.
This makes sense as the jobs market is a lagging indicator and is typically one of the last segments of an economy to show weakness during a downturn. Companies are starting to feel the pinch of higher input costs (thank you, inflation), which will shrink corporate margins.
As a result, companies will likely scale back and tighten up the ol’ recession belt, which means a lower headcount. When revenue slows and costs increase, companies will undoubtedly reduce non-critical workers.
We think we are at the market cycle phase where companies are starting to weigh job cuts.
What Does This Mean For Stocks?
Well, initially, it’s not great because it means that margins are shrinking for some reason. But, in the long term, it is a good thing. Companies will be able to increase their efficiency by streamlining their processes in a way that reduces costs for their customers. And in an environment like this, we can use more cost reductions.
Recessions also allow unprofitable companies (i.e., poorly run companies) to file for bankruptcy. Poorly run companies are a drag on society as they offer poor service and prices. Removing them is good for the average consumer.
Recessions typically occur due to some type of economic imbalance, usually a misallocation of capital. A recession can remove this misallocation by driving down asset prices, such as housing and equipment.
It is also important to note that market cycles are a normal part of life, even though this one could’ve been avoided. As mentioned earlier, we will likely face a recession soon, so the smart move is to find ways to take advantage of it rather than fret about it.
Buy The Dip
We could be wrong, but we see lower lows as inflation continues to ravage the global economy. Europe is particularly vulnerable as they face dire energy constraints.
As such, we see the Federal Reserve continuing to be unaccommodating in the near term until inflation levels fall. Also, fear hasn’t wholly gripped the market where the average investor is throwing in the towel.
However, once the market begins to suspect that the Federal Reserve pivots to be more accommodative, the market and all other risk assets will recover quickly. This will happen, as we have seen in the past.
Before this happens, investors will likely be faced with a great opportunity.
We are working with our clients that have cash on the sideline to take advantage of lower prices by identifying particular entry points. Timing the market on a day-to-day basis is a fool’s game, but buying on significant pullbacks is an intelligent strategy.
Investing in S&P 500 pullbacks of 30% or greater offers an attractive overall return.
It is important to note that you should not sit on cash for too long. It is risky to sit on the sidelines for the longterm, even if you are waiting for an opportunity like this (you will miss out on so much growth!). However, if you happen to find yourself sitting on extra cash, data shows that you should take advantage of significant market drawdowns.