Whenever you find yourself in the majority, it is time to pause and reflect.
-Mark Twain
Without its famous ending, I’m not sure the 1968 movie “Planet of the Apes” with Charlton Heston would have become the hit and franchise spawn it became. We all know it of course, at least those of us over a certain age. Taylor takes off into the Forbidden Zone where he sees the half-buried Statue of Liberty and gives us that great “you maniacs…” monologue that has been parodied by Mel Brooks, The Simpsons and countless others. Of course, what Taylor learned in that iconic, ending moment was that he had been on earth all along. I bring this up because what if, as we all prepare for a recession that may come later this year or early next – we’ve really been in a recession the whole time?
This is probably not the case and most experts would agree; but the final GDP numbers for the first quarter came out and the economy actually contracted 1.5% that quarter. This is being attributed to two distinct events that have not repeated since, the Omicron wave of Covid that started around Christmas time and consumed the month of January, and the start of the Ukraine invasion in February disrupting global commodity markets. This quarter we are supposed to see 3.0-3.5% growth, making up for the first quarter, and since you need two consecutive quarters of negative growth for a recession – we would avoid that status. But that projected three-percent-plus, second quarter GDP growth, as Steve Miller Band might sing is slipping, slipping, slipping. Currently the Atlanta Federal Reserve, which does a measure it calls “GDP Now” that tries quantify the Quarterly GDP number in real time, has that figure at only 1.3% for this quarter. They had projected 2.4% in the middle of May. This statistic is not perfect, they’re trying to measure a notably difficult thing to capture in the moment, which is why the official numbers come out more than six weeks after the end of each quarter, but the direction of this measure has been pretty accurate even as the exact numbers are not always correct. For example, in the first quarter the GDP Now estimate in early January was 5%, and ended the quarter at only 0.9%. While this was an incorrect number, it did pick up the deceleration that led us to that 1.5% decline. If this number somehow ends up negative, then we are in a recession, even as unemployment continues to drop dramatically. What would this mean for the Federal Reserve that assumes it can raise rates because there is enough slack in the economy to accommodate those hikes? This is why I was advocating for the Fed to start raising rates last fall. As of now, the Fed still seems committed to raising rates a full 0.50% in June and July.
This brings me to the markets and trampolines. In that apparently recessionary first quarter, the markets (as measured by the S&P 500) went down almost exactly 10% and then bounced back off that level, before falling again to be down about 13% and then bouncing back to end the quarter being down only about 5% in total. Then the selling began again, and the markets blew back through that 10% and 13% level until it hitting almost exactly 20% down on Friday, May 20th at around 3PM. Somehow the markets ended that day almost flat, as if there was a trampoline sitting at the exact Bear Market level (20% down) that pushed the market back up. Since that day the markets have recovered somewhat, very similar to what happened in the first quarter. We haven’t had enough time to know if this comeback will be as strong as the one in March of course. The markets always bottom out at some point, but what worries me about this particular bottom is that it seemed to hit at an exact market level, normally markets bottom at some random number. The fact that this looks so much like what happened in March also leads me to believe that these are “programmed” trades. Buyers who have put in purchase orders when the market hits a particular level. These are often called “resistance levels” in our business and rarely do they look so clear. The 10% level back in March is a nice round number and that 13% level also corresponded to almost exactly 4,200 in the index so perhaps that’s why a seemingly odd percentage became a resistance level. This bounce off 20% was so profound that it can’t be a coincidence. But what does that mean? It means one of two things; first the possible good, that 20% level may have staying power and perhaps the worst of the 2022 sell-offs are over. The possible bad, which I hate to say is probably more likely, is that the next time the markets hit that 20% level, all those program trades have washed out – just like in March with the 10% and 4,200 levels – and we drop down further before finally finding a bottom. Where exactly that bottom is, I don’t know, but I do know that a lot of investments are suddenly getting very attractive from a valuation and dividend paying level, so I’m optimistic that we’re closer to the bottom than to the top. There’s also a stat that when the markets sell off in the first half of the year they rise the second half of the year, but as a wise man once told me, “Trends always work until they don’t.”
Either way, I wouldn’t fear the recession if we get one. Everyone is worried about the future, when we just lived through a recessionary quarter and it wasn’t so bad. The real downside of recessions is the job losses. If you are in a secure job or you’re already retired then the most damaging part of a recession is not on your radar screen. Plus, the current inflation is far more damaging to most of you out there than the potential for an economic slowdown. What good does a 10% up year in the stock market do you if inflation is even higher? Knocking inflation back down to 2-3% at the sacrifice of one down stock market year doesn’t seem so bad to me, and I think the Federal Reserve is thinking the same thing. With that said, I’m still playing the under for this year. What I mean by that is the Fed will continue to raise rates but I don’t believe they’ll get to the full 3% rate by December. The Feds “Preferred” gage of inflation showed a slow down between March and April – just as I predicted it would. It still rose 4.9% which is far too high, but it looks like it’s slowing down. At some point I still believe the Fed stops rate increases for a month or two to see how their tightening is working. After the Fed minutes came out on Wednesday, May 25 the markets rallied quite a bit. Those minutes seemed to indicate the Fed would raise rates even higher, if necessary, beyond that 3% level, which you would think would hurt the market. However, the wording made the time frame on getting beyond that 3% level seem further out than this year, which had the opposite affect – at least short-term.
Just as I advised many of you in person and all of you through this newsletter to use the up markets of the second half of last year to set aside cash for any big purchases you may be planning for the next year or so, I now advise the opposite. If you can help it, maybe you should put off the new car or the full kitchen remodel for a while. Not only are the markets down, the price of those things is pretty bubbly as well. Of course, this is what the Fed is hoping for – that lots of people do that same thing so the demand for these goods that are in short-supply dries up, and the prices can come back down. With that said, if you are positioned correctly there should be somewhere you can go to get some money in an emergency, and any money you need for the next couple years shouldn’t have been affected by this market swoon. If you are not a client of ours and don’t feel like your investments are properly diversified for a downturn (it’s easy to invest when the markets are up) then give us a call. For the rest of you, we are accepting new clients.
