Rush to Recession
"I’m not a fan of MMT — not at all,
We don’t need to get into danger zones,
and we don’t know precisely where they are.”
― Warren Buffett, democrat
The S&P 500, our benchmark index is up 13.35% as of Friday, while Stay Invested is up a mere 7.23%. I have three things to say, 1) 13.35% is amazing and for those who bought an S&P 500 Index as I have encouraged many times, you've done very well. 2) 7.23% is a great return given that a 10 year bond pays about 2.5% and a savings account or CD just slightly higher and the long term S&P average is around 8%. 3) We've achieved 7.23% YTD with much lower volatility than the broad market and with a small portion of our cash put to work. We have a big cash drag because finding those bargains is getting tougher. But I won't cry over what we've done so far.
Rushing To Recession
I'm at my wits end with all the recession talk and the dog pile barking from all sides is just being exacerbated by talk about slowing global growth. There seems to be a general sentiment that a recession has to happen soon because a 10 year bull market is too long.
"Milk comes with an expiration date,
bull markets don't"
Show me the data, but tell me the story too.
To tell you the truth, I struggle with data and number crunching, but I love the story that the numbers tell me. To help me through the tough numbers I have resources and friends to turn to; but in the end the numbers only make sense when the story they tell also jives.
Data by itself can be interpreted in many ways. An argument can be made on either side of this recession & slowing global growth debate. I can argue that the world is flat and there are those who will argue I'm wrong. I'm confident we will both present reasonable data to argue our point. Just because one argument sounds reasonable doesn't mean its right. For the record, the world isn't flat.
For some reason we humans always gravitate to the negative argument.
Something I've noticed is that pundits who are bearish about the stock market and the economy always sound more sophisticated than their bullish counter parts. Make no mistake, I am a perma-bull when it comes to the stock market, but the perma-bears aren't always right any more than the perma-bulls are. The majority of newsletters that talk about the markets focus on negative sentiment and catastrophe scenarios. A daily dose of how wonderful everything is just doesn't sell newsletters or produce TV ratings. Sometimes the bears are right, but mostly its just a lot of hyperbole to get us all worked up to tune in and read their newsletters. Below I discuss how this can be used to an investors advantage.
Where's the Recession?
The last seven (7) recessions have all been proceeded by a complete shut down in credit. Knowing that makes it easier to understand all the hoopla over the Inverted Yield Curve. When short term rates (90 day note) are higher than long term rates (5 year treasury) we say the yield curve is inverted. Put simply, if a bank borrows money at 3% they can't make you a loan at 2.5%. If banks aren't lending, the economy shuts down.
Looking back at past federal reserve actions, the Fed has historically raised interest rates on the short end (discount window to banks) too high and too fast for rates on the long end (market driven) to stay ahead. Recessions are Fed induced. What's scary is that every Federal Reserve Chair has had some excuse, some reasonable negative argument for what they did to explain how necessary it was to raise rates to prevent inflation or some other dire consequence.
The bottom line is that banks don't care what the Fed's reasons are for raising rates. If The Fed inverts the yield curve and it stays there long enough, banks stop lending until conditions change and they can make money on loans again. That's it, there's nothing more complicated to all this yield curve nonsense than that.
The primary indicators of a recession are when we have confirmation from all of the following indicators,
1) Short term interest rates higher than long term rates for an extended period of time,
2) ISM Manufacturing Index from it's peak indicates a recession 3-4 years away,
3) NFIB Confidence Index from its peak indicates a recession is about 4 years away. Since small business drives the US economy this is an important indicator.
There is no single indicator that foretells a recession and the time lag is so long that you only know you're in a recession when we're either mid-way or already out of it. The advice here is, Stay Invested and stop trying to build a portfolio around a recession. Besides, recessions are bullish indicators offering great opportunities to buy the market at a discount with the historical evidence showing that out sized returns are soon to come. Recessions are only bad things if you're not invested.
When would I stop Buying?
Recession fears seem to go hand in hand with "Get out of the stock market", when in fact the opposite is true. So if I am again to try and explain myself, the real question is, "When would I stop being a buyer of stocks?"
"Be greedy when other people are fearful,
Be fearful when other people are greedy"
- Warren Buffett
Sage advice like this from Warren Buffett needs to have the right place in your investment work. It's a cute saying, but how do you put it to practical use?
My thinking is that since newsletter writers predominately write about the negative news, any change in that negative sentiment should indicate that the market is facing a pivot point. The best way to check financial news writers in aggregate is to check the Investors Intelligence Advisers Sentiment Report. When the sentiment changes from mostly negative to mostly positive this is likely an indicator of a major market shift as the newsletters violate their discipline. Turns out that the IIASR has been accurate since the 1960's when they first started collecting data. This should tell us all that we don't need to be on recession watch, we need to be on sentiment watch.
Looking at the Bulls/Bears/S&P chart below we can see that when the IIASR drops below zero, indicating strong negative sentiment, the stock market rallies, often with great strength. And when sentiment is well above zero in the 35%-45% range we see significant declines in the S&P 500. With all this negative sentiment, we are our own worst enemy when it comes to investing. A drop below zero indicates that we are approaching peak negative sentiment, while a rise above zero to the 40% line makes me want to raise cash and a rise to 50% or greater has me tightening my seat belt for the ride down. The far right side of the chart is showing the big decline we experienced last December, Q1 2019 remained difficult as first quarter usually is; call it seasonal declines. We are now at the point where the negative sentiment should pivot and the markets should respond by going higher.
The short answer to my question, I would stop investing and go to cash when credit dries up and neither businesses or individuals can get loans. And as soon as that condition showed signs of changing, I'd buy the stocks on my pre-prepared shopping list hard, really hard.
Where is the Slowing Global Growth?
The other part of the current negative rhetoric is that we are experiencing a global growth slow down. So growth is slowing, its not contraction. If that's all we have to deal with than lets rejoice that the economy is at least growing, albeit slower. However, I don't buy into the global growth slow down story. If I cherry pick the right data I can make up a story that says the global economy is slowing and recession must be just ahead.
My news letter is free, what possible benefit is there in telling a negative story?
From my view I see that short interest rates are contrived because the Fed simply wanted to add some margin to be able to reduce rates if the economy did slow down. That hasn't happened and the Fed stopped raising rates. The Nikkei is up almost 9% YTD, NASDAQ up 47% YTD, DOW up 40% YTD, Shanghai Composit up over 30% YTD, FTSE 100 up 45%, DAX up 21.75%, even the Paris CAC 40 is up over 12% YTD. Crude oil closed at $63.44 on Friday, that's up 34.3% YTD. Employment numbers are strong, heating oil, natural gas, all the metals, especially Copper are all up meaningfully year-to-date. Commodity prices are climbing but still low because employment is so high which could be an indication that our job market has a ways to go before reaching peak employment. Month-Over-Month S&P earnings are still growing. We did over 21% last year and still the S&P earnings is growing m-o-m.
Back in December 2018 adviser sentiment, the VIX (fear gauge), put/call ratios and general survey sentiment was as low as we had seen since 2008. Yet here we are approaching all time highs. We were suppose to have a recession, what happened.
Historically all the data is indicating that we are in the early stages of a prolonged bull run in the stock market.
What's the catalyst?
The best part about the current economic environment is that we haven't yet seen all the catalysts play out. By catalyst I mean stimulus that can further grow and expand our economy. In 2019 we should see a Transportation Bill passed, huge stimulus. China should begin buying U.S agricultural products and likely at multiples that benefit U.S. farmers. I'm going to take a wild guess at $500 billion/year for the next 5 years; that's a big stimulus. The new NAFTA (USMC) has not yet been felt in the broad economy, that's a big stimulus waiting in the wings. Repatriated cash is still coming in and hasn't yet been reinvested on shore. While capital expenditures are at historically high levels, there is still a lot more room for U.S corporations to spend more on capital expenditures; arguably the most important aspect of the new tax law. Those Cap-Ex investments, they put a floor under the economy and set us up for future growth with greater productivity, modern plants and equipment.
My basic premise is that there are a great many things hanging out there that haven't yet been felt by the global economy. If you're holding your breath for a global economic slow down and a recession, I think you're going to be disappointed.
The Market is Too Expensive?
This is where the bears always sound so friggin' smart. Seriously, you go to a party and people talk about the stock market and how over priced stocks are, and interest rates are going up; yeah I've heard someone say that interest rates are going up! The other people who don't follow the markets tick-by-tick; they eat this up. Here's a mantra I love, "The S&P is trading at 17 times earnings, that's high historically". Well actually its fair value as the S&P historically trades at 16X - 18X. But this argument doesn't make any sense, its basically a way for this person to convince themselves that their unfounded fear is real.
Money has to go somewhere, it can't just sit under the mattress and hope for a better day. When people tell me the stock market is expensive, I ask, "Compared to what"? Where else is money going to go to earn a reasonable rate of return? When choices are a CD savings account at 2.75%, a 10-year bond at 2.5% or the stock market at 13.35% (8% over longer periods), there's no question that stocks are the best wealth generator available. The stock market isn't expensive, staying out of stocks is very expensive. When that 2.5% yield looks attractive, remeber that it comes with 2% inflation; its actually a 0.5% yield, or zero.
Hold On - The Bull is going to rage
I'm making a big call today, a call that is contrary to consensus and flies in the face of all the prognosticators on Wall Street; the 10-year old bull is about to bust down the gate and rage. There is no recession in sight and the global growth story is still in tact. I remain confident in my S&P 500 target of 3,000 by year end.