The R-word rhetoric got stepped up last week. In between increasingly tiresome inflation anecdotes that seem to pop up everywhere from social media to groups of smokers in front of NYC bars, the hot topic has been The Recession.
In today’s report I’m going to dig a little deeper in what a recession is, what it isn’t, how to recognize one and why it just may not be the stock market catastrophe that it is usually portrayed as.
Given the previous week’s carnage and a pretty news-deficient long weekend, a bounce back from oversold conditions on Tuesday was completely unsurprising. There even seemed to be some evidence of a bit of old-school BTFD (remember when that was a thing?).
The Three Keys to a Bottom (peak Fed hawkishness, peak inflation, declining geo-political risk) remain in effect and none have yet been fully triggered although we could start to see some improvement in the first two as the Fed’s favored measure of what it would call true inflation, the Personal Consumption Expenditures index, comes out this week. A benign reading would indicate the inflation could be peaking, potentially reducing the need for such a hawkish stance from the Fed and will cheer Wall Street. But if more of the same, skyrocketing inflation for at least another month with no end in sight, is indicated - look out below.
Fed Chair Jerome Powell, talking to Congress, continued to stress that he believes that the economy can handle higher interest rates. However, he also admitted in response to Senator Elizabeth Warren's questioning that higher interest rates are not going to do anything to help with lower food and energy prices. Finally! Someone actually came out and said what we have all known for months!
Powell said that while it was possible that the Fed could help orchestrate a "soft" economic landing and avoid a recession it was important to understand that “recession is certainly a possibility. Frankly, the events around the world over recent months make it [the soft landing] harder” clearly referring to the war in Ukraine and lockdowns in China that are exacerbating food and energy inflation and the world’s supply-chain problems.
Markets didn’t respond well to all this long overdue honesty and an unexpectedly frank assessment and what was shaping to be quite a nice follow-up to Tuesday’s bounce began to fizzle fast as Powell’s words were digested and Wednesday ended up in the red after a late collapse.
Later in the week, however, we saw a quite meaningful rally in stock prices, as oversold conditions proved too tempting to ignore while the financial newswires were generally quiet and we began to see the (mostly stock market-positive) effects of both index and portfolio rebalancing as well as window-dressing (see FINANCIAL TERM OF THE WEEK below) in advance of the upcoming end of Q2.
It also didn’t hurt that on Friday, the U.S. Federal Reserve released a report showing that all major U.S. banks passed its stress-testing Comprehensive Capital Analysis and Review. This is welcome news for the market with recession on everyone’s mind.
So let’s turn to the R-Word. Broadly speaking, a recession is popularly defined as two consecutive quarters of negative GDP growth as determined by the National Bureau of Economic Research (NBER), although technically there are other factors that may be taken into account in determining if a recession has “officially” occurred. The point here is that it’s very much a backward-looking endeavor that’s mainly aimed at economic historians years from now and posterity in general. It is not intended for present day consumption or decision-making and certainly has no predictive qualities whatsoever. Recessions are often identified by NBER as having been in place long after the real slowdown in the economy has ended and the recovery is in fact already underway.
Frankly the only way to really know we are in a recession in real time is anecdotal. Friends and family members start getting laid off or having a difficult time of it at work. You see abandoned construction sites in your town. Stores close. Yes, there are a few stats that can indicate a concurrent recession (Purchasing Managers Indexes falling below 50, unemployment numbers starting to spike) but it’s remarkably tricky to know if one is currently experiencing one.
By virtue of her tweet: “When y’all think they going to announce that we going into a recession?”, we know that Cardi B for one is breathlessly waiting for an official recession announcement at some imminent Treasury press conference or something. Sorry Cardi, that just isn’t going to happen. If we are currently in a recession today, we’ll probably find out for sure about it towards the end of the year - by which time we may well no longer be in recession.
So what you potentially have is an extremely forward-looking animal (the stock market) colliding with a very backward-looking one (an official recession declaration) and that can often mean that the damage and the pain can be mostly over by the time we know for sure what the reason for it is. The stock market may well be looking beyond any recession very soon and that is why we need to focus on what is stirring beneath the surface of the market in terms of broad supply and demand rather than reacting to real time events when it comes to figuring out when the skies are beginning to clear. And you’ll find that in my ”Under The Hood” section every week in this report.
When looked at in this context, recessions aren’t necessarily always the stock-killers they may seem. Tom Essaye’s Sevens Report ran the numbers which showed a surprising outcome. Using periods beginning six months before the official recession start dates and ending six months after the official recession end dates, he found that, of the eight official recessions since 1969, five of them saw pretty meaningful S&P 500 price increases over those time periods, moving higher, on average, by a very healthy 14%.
It should said that the other three (1970s stagflation, the dot.com crash of 2001 and the late 2000s financial crisis) did indeed inflict long-lasting and intense damage to stock markets, but the assumption that a recession and a hefty stock market crash inevitably march hand-in-hand in simultaneous lockstep is simply not borne out by the data.
Summing up, while recession is a major buzzword right now, don’t let it significantly scare you. Recessions themselves are arbitrary designations and the economy slows well ahead of them and market declines tend to occur a long time before they are declared. By the time the economy is deemed to be in one, stocks can often have already bottomed out and are looking towards the recovery.
What matters far more than whether a recession exists or not is its duration once it has been determined that it is in place. The three “bad” ones each lasted for a long time and proved far more destructive than the other shorter ones. A short recession, even if it is intense, is going to hurt far less than a long-drawn-out affair that may never reach that level of intensity, but just drags on and on.
Other News:
Falling sales, rising prices .. Record-setting prices and rising mortgage rates sent sales of previously-owned homes to their lowest level in almost two years. The number of existing home sales 3.4% from April to May, the fourth consecutive monthly decline and the fewest sales since June 2020. That’s 8.6% lower than a year ago. The amount of home sales have essentially round-tripped back to levels seen in early 2019 before the COVID outbreak.
Further declines in sales should be expected in the coming months because of the industry euphemistically calls “housing affordability challenges”. The median price for an existing home went above $400,000 for the first time ever, reaching $407,600, a 14.8% rise over the last year.
Bye, bye Juul .. The U.S. Food and Drug Administration (FDA) announced plans last week to limit nicotine levels in cigarettes and then ordered Juul to be completely shut down, pulling all of its e-cigarette devices and pods from the US market with immediate effect. Altria/Philip Morris (MO) paid more than $12 billion for a stake in Juul in 2018. Even prior to the FDA’s announcement, that stake had collapsed in value to be worth less than $2 billion, according to recent disclosures from Altria. And it’s now going to be worth a whole lot less, if anything at all.
Predictably, when the Wall Street Journal broke the story on Wednesday, MO stock got whacked.
The employer match is great, but .. Workplace retirement accounts can make investing for your retirement easy, and many employers even offer a match. But matches often come with a big caveat, i.e., your vesting schedule, whereby you are not entitled to any or some of your employer match until you have worked for them for a number of years. Vesting doesn’t really encourage you to stuff your 401(k), it encourages you to stay at your employer longer. And if you stick with the same job for a long time, you could be forfeiting a higher salary elsewhere. In this era of the Great Reset, the smart $$$ move might just be to stop waiting for your employer retirement match to vest and change jobs instead.
The current state of employer matches looks like this: 47% of employers make workers wait at least three years for their matching retirement account contribution to fully vest, but many employees don’t get to that point. Millennials on average spend two years and nine months in any given job, compared to over five years and eight years for Gen Xers and Boomers, respectively. This means younger workers are more likely to lose out on some or all of their employer match.
The projected average raise for people working in 2022 is 3.9% and the typical employer retirement account match is 50 cents for every employee-contributed dollar on the first 6% of pay (meaning, if the worker puts the full 6% into their 401(k), their employer will top it off with an additional 3% contribution). So, on average, staying another year at your job translates to a 6.9% gain for you, unless you aren’t vested yet. On the other hand, many job switchers can expect more than a 6.9% increase in compensation.
Of course the best solution is immediate vesting. It’s offered by 28% of employers, so we know it’s totally worth you nagging your boss for.
Under The Hood:
A number of technical analysts are identifying the S&P 500 level of 3800 as a very important. If the market can stay above that level (it closed Friday at 3911) then it could have the potential to squeeze prices violently higher, at least for the short term, but if the index sinks back below that level and can’t make it back again in a series of failed assaults, it would show solid resistance there and could lead to a further significant decline.
I am somewhat skeptical of the practice of drawing rather subjective lines onto a chart and drawing consequential conclusions from where that line extends out to and nor am I a huge believer in the power of “round numbers” when it comes to index levels, but sometimes enough people believing something can be sufficient to make it happen.
What we really need to look at is supply and demand. We have seen multiple days of intense selling suggesting that, finally, the exhaustion of Supply we have all been waiting for may well be in progress. I tend to agree. However, the key term here is “in progress”. It is human nature to look for bargains and investors often think they have found what they are looking for just because they are looking for it so desperately. “Stocks must be cheap”, goes the narrative. The problem is that low prices do not necessarily equal good value.
The first thing we need to see is a very sharp drop in Selling Pressure, the key measure of Supply that I track every week in this report. As sellers eventually become exhausted, they become weaker with fewer shares available to sell. Next needs to come a real spike in Buying Power, the key measure of Demand (also tracked in this report), which demonstrates that prices are finally low enough to attract serious buying. In the current market, Buying Power still remains closer to its 2022 lows than to its highs, so some patience is needed.
The final piece of the jigsaw is that conditions need to be heavily oversold (which can be measured by the Relative Strength Index - RSI, which is also tracked in this report) for a rally to succeed, which essentially represents how far back the rubber band has been stretched before it is let go.
While it might be that the process has indeed begun, it is definitely not complete. Buyers and sellers are still slugging it out, the referee has not stepped in to stop the bout yet.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
The upcoming week’s calendar ..
It will be an economic-data heavy week, but there are still a few notable companies reporting earnings or having investor days as well. They include FedEx, Nike, Hewlett Packard, Walgreens, General Mills, Micron Technology and Jefferies Financial Group.
On Monday, we get the durable goods report for May, which will give insight into business investment and consumer spending. On Tuesday is the release the Consumer Confidence Index for June. Inflation remains top of mind for consumers.
Later in the week we have personal income and spending data for May. That release includes the Personal Consumption Expenditures index, which is the Federal Reserve’s preferred inflation gauge. Wall Street will be looking closely for elusive signs of a peak in inflation.
The release of the manufacturing purchasing managers’ index on Friday will be more closely examined than usual as it is one of the few data points that can point to the state of economic growth in mostly real time. It is forecast to decline slightly from May's reading, but remain solidly in expansion territory.
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US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months):
↑Bullish: 18% (down from 20% the previous week)
→Neutral: 22% (unchanged from 22% the previous week)
↓Bearish: 60% (up from 58% the previous week)
Net Bull/Bear spread .. ↓Bearish by 42 (Bearish by 38 the previous week)
Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Bull-Bear spread: Bullish by 8
Source: American Association of Individual Investors (AAII). All numbers rounded.
LAST WEEK BY THE NUMBERS:
- Last week’s best performing US sector: Consumer Discretionary (two biggest holdings: Amazon, Tesla) - up 8.1%
- Last week’s worst performing US sector: Energy (two biggest holdings: Exxon Mobil, Chevron) - down 4.28%
- The NASDAQ-100 outperformed the S&P 500
- US Markets did much better than International Developed Markets and Emerging Markets
- Large Cap fared somewhat better than Mid or Small
- Growth solidly outperformed Value
- The proprietary Lowry's measure for US Market Buying Power is currently at 173 and rose by 13 points last week while that of US Market Selling Pressure is at 198 and fell by 7 points over the course of the week
- SPY, the S&P 500 ETF is still below both its 50-day moving average and its 90-day and also remains a long way below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 48**. SPY ended the week 18.3% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, is still below both its 50-day moving average and its 90-day and also remains a long way below its long term trend line. The 14-day Relative Strength Index (RSI) reading is 50**. QQQ ended the week 27.0% below its all-time high (11/19/2021).
** RSI readings range from 0-100. Readings below 30 tend to indicate an over-sold condition, possibly primed for a technical rebound and above 70 are often considered over-bought, possibly primed for a technical decline.
- VIX, the accepted measure of anticipated upcoming stock market risk and volatility implied by S&P 500 index option trading (often referred to as the“fear index”) ended the week lower at 27.2 and is now below its 50-day moving average and just above its 90-day. It continues to be above its long term trend line.
ARTICLE OF THE WEEK:
Each week I'll link to an interesting article I have come across recently.
This week: Buy a f*****g latte! Ignore the stupid nonsense from Dave Ramsey, Suze Orman and the rest. That’s not where the problems lie.
FINANCIAL TERM OF THE WEEK:
A weekly feature using information found on Investopedia (may be edited at times for clarity).
Window dressing is a strategy used by mutual fund and other portfolio managers to improve the appearance of a fund’s performance before presenting it to clients or shareholders. To window dress, the fund manager sells stocks with large losses and purchases high-flying stocks near the end of the quarter or year. These securities are then reported as part of the fund's holdings.
The term can also refer to actions taken by companies to improve their forthcoming financial statement, such as by postponing payments or finding ways to book revenues earlier.
How it works .. Performance reports and a list of the holdings in a mutual fund are usually sent to clients every quarter, and clients use these reports to monitor the fund's investment returns. When performance has been lagging, mutual fund managers may use window dressing, selling stocks that have reported substantial losses and replacing them with stocks expected to produce short-term gains to improve the overall performance of the fund for the reporting period.
Another variation of window dressing is investing in stocks that do not meet the style of the mutual fund. For example, a precious metals fund might invest in stocks in a hot sector at the time, disguising the fund's holdings and investing outside the scope of the fund’s investment strategy.
A fund investing in stocks exclusively from the S&P 500 has underperformed the index. Stocks A and B outperformed the total index but were underweight in the fund, while stocks C and D were overweight in the fund but lagged the index.
To make it look like the fund was investing in stocks A and B all along, the portfolio manager sells out of stocks C and D, replacing them with, and giving an overweight to, stocks A and B.
For investors, window dressing provides another good reason to monitor your fund performance reports closely. Some fund managers might try to improve returns through window dressing, which means investors should be cautious of holdings that seem out of line with the fund’s overall strategy.
Exchange Traded Funds (ETFs), which typically publish their holdings daily, not quarterly, are not subject to window dressing like mutual funds are.
The act of window dressing is under close watch by investment researchers and regulators with potentially forthcoming rules that could require more immediate and greater transparency of holdings at the end of a reporting period
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