Debunking The Myths – Recessions & Stock Returns

Famed American Economist Paul Samuelson years ago joked, “Economists have predicted nine of the last five recessions,” and forecasting today remains as fraught with peril as ever. After all, calculations from Bloomberg have shown a 50% or greater chance of recession over the ensuing 12 months since last August, yet real GDP growth for Q4 2022 came in at an impressive 2.6%, the Atlanta Fed’s current estimate for Q1 2023 growth is 2.5% and the latest projections from the Federal Reserve call for GDP to grow 0.4% this year and 1.2% in 2024.

To be sure, the Bloomberg recession estimate now stands at 65%, while the latest read on the forward-looking Leading Economic Index (LEI) fell by 0.3% in February. The keeper of that gauge, The Conference Board, asserted, “While the rate of month-over-month declines in the LEI have moderated in recent months, the leading economic index still points to risk of recession in the U.S. economy. The most recent financial turmoil in the U.S. banking sector is not reflected in the LEI data but could have a negative impact on the outlook if it persists. Overall, The Conference Board forecasts rising interest rates paired with declining consumer spending will most likely push the U.S. economy into recession in the near term.”

The future is murky even for Federal Reserve Chair Jerome Powell who in his post-Fed Meeting Press Conference last month did not state that an economic contraction was his projection. To be fair, he didn’t say that a recession would not occur, but when asked, “Do you still see a possibility of a soft landing for the U.S. economy,” the Fed Chair responded:

You know it’s, it’s too early to say, really, whether these events have had much of an effect. It’s hard for me to see how they would have helped the possibility—but I guess I would just say, it’s too early to say whether there really have been changes in that. You know, the question will be how long this period is sustained. The longer it’s sustained, then the greater will be the likely declines in—or tightening in credit standards, credit availability, so we’ll just have to see. I do still think, though, that there’s a—there’s a pathway to that. I think that pathway still exists and, you know, we’re certainly trying to find it.

The Prudent Speculator Banking on Value Stocks

DIFFERENCES OF OPINION

What’s more, this week, we heard from two executives of prominent American financial institutions with conflicting views. Bank of America
BAC
CEO Brian Moynihan said inflation is showing signs of cooling, but the U.S. economy will still face a recession. Nevertheless, on BAC’s quarterly conference call, Mr. Moynihan hedged when he said, “Everything points to a relatively mild recession given the amount of stimulus that was paid to people and the money they have left over.”

On the other hand, Blackrock (BLK) CEO Larry Fink cited stimulus from the Infrastructure Bill, the Chips and Science Act, and the Inflation Reduction Act as reason to think a U.S. recession won’t occur. In a television interview, Mr. Fink elaborated, “Those three bills are a trillion dollars of stimulus over the next few years. Think about how many jobs infrastructure creates. Think about the demand for commodities as we build infrastructure.”

KEEPING THE FAITH

Needless to say, the economic crystal ball is cloudy, so many investors are likely sitting on the sidelines, even as crunching nearly a century of data supports the view that the only problem with market timing is getting the timing right.

We looked at all of the National Bureau of Economic Research’s (NBER) declared recessions since 1929 and calculated returns for Value Stocks and Dividend Payers preceding, during and following each economic contraction. Equity returns in the lead-up to the recessions were generally good (averaging 9%) and we think one wouldn’t want to miss out on those gains. Not owning stocks during recessions would spare modest losses, but the NBER doesn’t determine recessions in real time, meaning the recording lag significantly complicates timing this type of trade. And, the performance numbers have been stellar, on average, coming out of recessions!