Not All Bear Markets are Recessions, Not All Recessions are Crises
In our last piece, The Yield Curve’s April Fool’s Joke | RMR Wealth Builders, Inc., we explained how, despite an inversion of the 2Yr/10Yr yield curve (that lasted a split second), the underlying economic and earnings data was solid. It is the data that strongly suggests that consumer balance sheets and savings have never been healthier. The labor market is one of the tightest it has ever been, with jobless claims hitting a 53-year low in April.
Critics of these arguments may point out an alarming -1.4% GDP print revealed in the first quarter. However, according to ClearBridge Investments, the economy is in better shape than it may appear.
“There is more to the story, given a -2.5% contribution from (stronger) imports as supply chain bottlenecks have loosened. This paradox – a positive development (supply chain improvement) led to a negative headline outcome (a drag on GDP) – perhaps explains why financial markets treated the GDP report as “good news,” with equities rallying 2.5% that day.”
Record strength in job markets and consumers and improving supply chains are NOT characteristics of a typical recession. Yet we find ourselves in a falling market, beyond correction territory, and speculating about a potential recession. Why?
Inflation. Investors have been very nervous since the Fed raised its benchmark interest rate by half a percent in May. Both stocks and bonds also have witnessed sharp price declines due to the rapid increases in interest rates. Last week the 10-yr Treasury rate reached 3.17%, causing markets to swoon.
The tightening is expected to continue throughout this year and next year as the Fed attempts to fight an inflation problem not witnessed in 40 years. This is the first time in over a decade that investors have faced both a hawkish Fed and inflation pressure, which led to a rapid selloff in markets this year.
Tighter financial conditions only exacerbate other problems facing the U.S. economy. The ongoing Ukraine war has pushed energy prices up, with gasoline now selling for $4.50 a gallon. At the same time food prices, along with manufactured items, are witnessing a rapid increase in prices due to global supply chain issues brought about by the Covid lockdown in China along with the war in eastern Europe.
Although the latest GDP report showed improvement in supply chains, investor sentiment has not followed suit. The sell-off in the stock market has been fast and furious, and we find ourselves 20% from previous highs. A technical bear market is defined as a drawdown of 20% or more.
Perhaps, most concerning is the lack of leadership by US mega tech (FAANG) stocks, which markets had become used to for over a decade. FAANG year-to-date returns: Facebook is -41%, Amazon -35%, Apple -20%, Netflix -68%, Alphabet/Google -21%, and also Microsoft -23% are all in sub-20%, bear market territory. These were considered the ultimate blue chips because they are leading innovators, who not only could participate in the upside but could also be relied on to recover quickly from drawdowns. This no longer appears to be unanimous.
As of May 16th, the S&P 500 Index has declined 17% and the NASDAQ is down 26% year-to-date. The bad news is that we may have more pain to go through before prices start to bounce back. Since WWII in 1946, we have seen 14 bear markets with an average return of -30% and an average duration of about 1 year. For this 15th bear market to get to the average, we would still have an additional ~10% to fall to the downside, and currently, we are only about 140 days into the cycle.
In other words, this bear market may still have some runway. Also, an elevated possibility of slipping deeper, perhaps into recession, lingers as the Fed seeks to pause economic growth. However, the U.S. economy is better equipped to handle such a reset, backed by a durable consumer and robust jobs market. The last time we had a recession, conditions were much worse. It was a systematic failure known as the Global Financial Crisis (GFC) of 2008-2009.
Since our last observed recession was an all-out crisis, many people associate the current downturn with similar extreme negative emotions and outcomes as the previous one. However, some investors have forgotten that pullbacks like these are a normal part of a healthy business cycle, especially following a torrid bull run. Thus, it makes sense the market needs to catch its breath after the S&P 500 climbed almost 50% from the end of 2019 to the end of 2021.
A slowdown does not mean the world is coming to an end or that you should move your portfolio to 100% cash. In the meantime, stay invested! Heed our warning about the dangers of market timing: Don’t Fix the Ship During a Sea Storm! | RMR Wealth Builders, Inc., and let your portfolio do what it was always designed to do. Because when a recovery finally sparks, it could be very rapid, and missing those few green days could be a devastating setback to building your wealth.
Sources:
AOR Update: Not Your Father’s Energy Crisis | Franklin Templeton
If this is a bear market, history shows the market has further to fall (cnbc.com)