Everybody’s saying that an economic recession is on the horizon in the U.S. Let’s define recession and put it into layman’s terms so that we can be clear on what to potentially expect. A recession is characterized by two successive quarters of falling gross domestic product (GDP).
We know that GDP numbers were incredibly strong in 2018 vs. years past. Would a potential recession mean that GDP is a little less strong now, or falling off a cliff?
What a Recession Would Really Mean
Imagine that you are a person who works on commission, and you receive your commission check each quarter. Your commission checks were generally in the $10,000 to $12,000 range in the quarters leading up to 2018. But then changes in federal income tax laws, repatriation of overseas cash, and deregulation suddenly gave your customers lots more money to spend. Your customers spent more money with you in 2018 than they had in recent years, and your quarterly commissions grew to a range of $15,000 to $18,000. As the year progressed, your customers found additional uses for their increased cash flow: hiring new workers, raising salaries, technology upgrades and new commitments to capital expenditures.
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Now you are creating your sales goals and personal budget for 2019. Your customers are still benefiting from changes in tax laws and deregulation, but they’re also continuing to fund the new business decisions that they made in 2018. So business is good, but they’re spending less with you than they did during their 2018 spending surge. Therefore, commissions are going to recede in 2019, maybe to a range of $13,000 to $14,000 per quarter. Therefore, your long-term income trajectory remains on a general upslope, while short-term income is projected to fall.
That’s how a recession will likely look in the U.S. Business is still good, employment numbers remain high, and inflation is not rapidly escalating, but it’s now harder to exceed previous quarters’ GDP growth because recent quarterly growth figures were somewhat abnormally high. I expect very attractive GDP numbers, but not quite as high as in recent quarters. That means we could easily see a recession in 2019.
What we’re NOT currently seeing is the prospect of a significant economic slowdown, which is typically accompanied by rising unemployment, and causes the Federal Reserve to lower interest rates.
A more serious recession occurred in 2008 when the housing market collapsed, which linked directly to the failure of many financial institutions. I think it’s fair to say that there is currently no alarming economic situation happening that can be compared to the housing and financial problems of 2008. I remember the U.S. government mandating that Fannie Mae and Freddie Mac lend money to people who had poor credit histories, and thinking to myself, “This can’t end well.”
Sure enough, the situation snowballed, leading to increased risk-taking in the financial community as traditional quality lenders relaxed their lending standards because they were otherwise losing business to subprime lenders. By the early 2000s, I constantly met people who were heavily invested in real estate, flipping houses, and stretching their credit lines in order to buy rental properties. These were not “Wall Street people”. These were neighbors and soccer moms and people at church. They were living out the quintessential Dire Straits lyric, “That ain’t workin’, that’s the way you do it, get your money for nothin'…”
In the financial world, when “everybody’s doing it”, it’s usually a bad idea. The U.S deserved that recession, because everybody had turned a blind eye toward the realities of credit risk – everybody from U.S. Congresspeople to day traders to grandmas.
How have stocks performed during previous recessions? In the five most recent recessions, dating back to 1980, stocks bounced around and finished recessions at higher points from where they started, except for the 2008 recession, which was clearly caused by a larger economic problem that dragged stocks down until March of 2009. And p.s., if a news report tries to use the 2008 stock market as an example of what happens to U.S. stocks during recessions, without showing you other recessionary stock statistics, that means you’re either dealing with a millennial in the media who has no experience with any prior recessions, or you’re dealing with a media representative who is scaring you on purpose so that their sensational headlines will attract viewers/readers.
As for bank stocks, a major Wall Street investment bank just published their analysis of bank stock performance during recessions. It turns out that bank stocks fare slightly better than the S&P 500 during recessions than they do during periods of normal, non-recessionary economic activity.
Each year, I review about 1,100 stocks in order to maintain a list of stocks with strong fundamentals, from which to make recommendations in Cabot Undervalued Stocks Advisor, and various other publications such as Forbes, TheStreet and Investopedia. My current “buy list” holds over 100 U.S. stocks. If there were something ugly happening in the U.S. economy, that list would contain 30 or fewer stocks. Quite simply, bad economies are made up of companies that are not thriving. Therefore, if I can find more companies than usual that are thriving – via strong sales, profits, cash flow, etc. – then we are not living through a bad economy. The results of my ongoing research tell me not to be concerned with the economy as we head into 2019.
What About the Market?
The stock market is a different animal from the economy, and over the short term, stock markets can move rapidly in either direction. Heading into 2019, I will be recommending purchases of healthy companies’ stocks, as long as their price charts indicate the bullish likelihood of rising share prices.
Most of the stocks that I follow, however, have bearish price charts right now. I will encourage people to hold off on buying those stocks until their price charts improve. Take heart! Even during stagnant and uninspiring stock markets, there are always opportunities to make money.
Read more in the weekly editions of Cabot Undervalued Stocks Advisor by clicking here.
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