recession

Viewing posts tagged recession

11 Mar 2025

Market Turbulence and Recession Fears: What You Need to Know

By glen

As stock indexes plummet from record highs, many investors are left wondering what’s next.  US stock indexes have been dropping over the last several weeks, causing investors much pain and consternation.  Suddenly, a possible recession is making headlines too.  Are these related?

Stock Market Decline

The stock market became way overpriced last year.  You can look at how “cheap” or “expensive” stocks are by considering what companies have earned or expect to earn.  This is commonly measured by comparing stock price to profit, which answers the question:  how much profit am I buying for each dollar of stock price?  Looking at the popular S&P 500 at the beginning of February, $22 bought you $1 of earnings.  The ten year average is $18 for $1 of earnings.  Through this lens, stocks were very expensive.

The stock market can gyrate between cheap and expensive regardless of what the overall economy might look like.  It’s normal for stock prices to “correct” after becoming too expensive, and that can happen even when the underlying economy is healthy.

The last several weeks have brought an unfortunate run of bad economic news.  At the beginning of February, the only thing holding up stock prices were “thoughts and prayers” because $22 is simply too much to pay for $1 of profit.  On February 28th a giant crack showed up in the economy, and suddenly the temperature had dropped, the wind picked up, and storm clouds were forming.

Economic Concerns Emerge

How much the US economy grows is measured by this thing called the Gross Domestic Product or GDP.  This measure has nothing to do with stock prices and looks at how much the US economy makes: factories, restaurants, construction, real estate, defense spending, the whole shebang.  The Atlanta Federal Reserve publishes a popular, and typically accurate, model of what the GDP number for the current quarter might be, since we don’t know the actual number until the quarter has long ended.

On February 28th the Atlanta Fed’s GDPNow model unexpectedly swung from a very healthy 2.5% to a negative number.  The fact that it fell off a cliff overnight was staggering and unusual.  The model is currently predicting first quarter GDP will be -2.4%.  This is one of the primary reasons we’re suddenly discussing a recession.

A recession is usually considered two consecutive quarters (six months) of a negative GDP number.  According to the GDPNow model we may already be at the beginning of a recession, and before February 28th this wasn’t on anyone’s radar.  Sometimes the model can be off, some data may not be accurate, there can be noise; however, as new data has been coming in, the model has stayed negative.

This creates a bigger problem for the stock market.  We discussed the value of stocks in terms of what companies are expected to earn.  With the economy suddenly shrinking unexpectedly it’s harder to know what companies might earn this year, which means it’s hard to know if stocks are cheap or expensive.  It will take some time for things to settle down and profit estimates to reflect changes in the economy.

What happened?  Let’s look at some other economic signs.  Inflation was almost back to normal; however, in January some readings stopped dropping and began to tick upward, and some measures of job growth began to slow unexpectedly.

The overall health of the US economy is rooted in inflation and employment staying in healthy territory, both of these appearing to slip at the same time is not a good sign, and the model quickly picked up on these changes.  That was all the stock market needed to “correct” or return prices to a more historically reasonable level.

Policy Uncertainty

While stocks were overpriced, the problems with the economy are rooted in tariffs, threatened and real, introduced by the new administration in Washington, D.C.  It’s important to note that businesses and financial markets (and many humans) hate uncertainty, and tariffs, threatened or real, created a tremendous amount of uncertainty.

It would have been foolish for businesses not to respond to real threats, and these responses caused a chain reaction as US and global companies positioned themselves for a tariff war.

If you owned shares in XYZ Corporation, and XYZ saw the tariffs coming to eat their business model, and management, knowing this, did nothing, you would call for management to be fired.  It’s not hard to see how this spreads.

In today’s world, tariffs are only useful in very specific situations, for example, when a country needs to protect a niche industry. It makes no sense to use tariffs on a large scale when you’re already the biggest and most powerful economy on the planet.

The other issue facing the economy are the large scale terminations of Federal workers.  It appears that little thought has gone into these initiatives, and we’re already seeing unintended consequences as civil servants are terminated.  These efforts will increase unemployment and create further drag as vendors and companies that supported these workers are impacted.  Consider the simple example of a “mom & pop” lunch counter near a shuttered office: now “mom & pop” are out of a job, their employees are out of a job, and they are no longer purchasing the goods and services used to keep their lunch counter going.

What This Means for Investors

The only silver lining for investors at the moment are bonds.  Bond prices have risen as investors seek safety, and bond holdings in portfolios have enjoyed a small boost.  If the Federal Reserve is forced to cut interest rates in the coming months, it will give bond prices another small boost.  In the meantime, investors can enjoy the continuation of elevated yields, which are the result of post pandemic inflation control measures.

It’s still possible for the US to avoid a recession.  The economy could find some lift, leaders could proactively take steps to stop making harmful policy changes, or some combination of factors, but at this point the damage has been done to people who own stocks, and that damage could worsen before we turn the corner.

If your portfolio has taken a beating, you are in good company; however, if you were unclear about how your portfolio is constructed, how it aligns with your goals, or if the answers you’re getting from your financial advisor don’t align with reality, this is a great opportunity to do some housekeeping and realign for the long run.

We’re here to help.

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities. 

29 Mar 2023

Banks: Canary in the Coal Mine?

By glen

We’ve been through a lot over the last three years.  It began with a once in a century pandemic that we were fortunate to survive.

To protect against another Great Depression, the Federal Reserve and Congress made it rain money, which helped keep homes and businesses afloat.  These actions had many unintended consequences.

It feels like we’ve been through a generation of crises in only three years.

  • Inflation become unhinged in a way we haven’t seen in forty years
  • The drop in stocks and bonds last year rivaled the worst bear markets in history
  • Falling real estate values in many areas was on par with the housing crisis
  • A strange speculative bubble came and went in crypto currency madness

Any one of these events in the financial world, in a vacuum, would have been a catastrophe, but in this era it’s been par for the course.

We’re now heading into what may be the last chapter of pandemic era financial stress.  The Fed has been aggressively increasing interest rates to combat runaway inflation, which slows growth by making it more expensive to borrow.  Three months ago we were expected to be in a recession by now, yet we’ve had a stellar first quarter, a testament to the strength of this economy.  But cracks are finally beginning to form, and those cracks are in banks.

To be clear, this is not a situation where you should pull your money out of banks despite two recent failures.  It rarely makes the press, but small town banks do fail, and the FDIC steps in to unwind them.  We have a lot of banks in the US.

A recent Bloomberg op-ed notes: “Canada has fewer banks than the state of North Dakota.”  Recent events have been eye popping because of the size of the banks that failed.  The US Treasury and FDIC have basically guaranteed all deposits at this point to assuage everyone, meaning everyone globally, our banking system is that important.

Silicon Valley Bank and Signature bank were victims of poor management and classic runs.  Deposits were pulled in a panic, and the banks were forced to sell bonds at losses on a massive scale to meet the demand for cash, which crushed them.

While deposits are implicitly protected, all banks are under similar stresses.  They must hold a certain amount of very safe bonds as capital, these requirements were bolstered coming out of the great recession.  These bonds have dropped in value with increasing interest rates, which means many, if not all, are holding massive amounts of bonds at a loss.  This gets ugly if they are forced to sell, which is how runs feed on themselves.  Either way, bank balance sheets are in a fragile state because they all face similar requirements.

Regulators were certainly aware these issues were festering across the board, but between the capital requirements and increasing rates, everyone is holding the same bad hand.

Regulators, facing public glare, will insist they improve balance sheets as quickly as possible, which means lending standards will tighten.  Over the next several months this will create another drag on the economy.  Banks lending less means businesses of all sizes will have less working capital.

The ironic upside, this dynamic will cool inflation.  Inflation still needs to drop by at least 50%, and the bank balance sheet contortion will mark the beginning of the end of rate increases for the Fed because it can’t afford to trigger another full-blown crisis.

The bottom line: the bank balance sheet issue could mark the catalyst for the long-anticipated slowdown.  Over the last several months expectations for a serious slowdown or recession have shifted to midyear, and this aligns with that timing.  While stocks will not like this, they haven’t gotten too far ahead of themselves coming out of last year’s brutal market.

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities. 

 

16 Feb 2022

Removing Life Support: Post Pandemic Challenges

By glen

 

When the pandemic began, the world’s largest economy was put into what can be thought of as a medically induced coma. The Federal Reserve and Congress took steps to ensure the patient would survive a trip to intensive care like no other. The world’s largest economy had never been put to sleep intentionally, and then revived.

Congress passed legislation to support employers, and employees, with things like paycheck protection, PPP loans, direct payments, and supplements to state unemployment benefits.

The Federal Reserve or “Fed” did what it knows how to do. It lowered interest rates, and printed a ton of money. The Fed essentially printed over four trillion dollars, that’s $4,000,000,000,000, for those who like to look at numbers. This flooded the US and global economies with cash.

These actions worked better than many expected. During 2021, the economy rebounded, and is now on a trajectory to pre-pandemic levels. Strong medicines can have strong side effects, and the most fearsome side effect of printing money is inflation.

The Fed had expected the inflation surge to pass quickly; however, supply chain issues caused inflation to become intrenched.

Wage increases became common, and are usually seen as a good thing. Who doesn’t like to make more money? However, as prices rise, wage increases are struggling to keep up. This begins what’s often called a “wage price spiral,” and it’s not a healthy pattern.

Most economists agree that it’s time to wake up the patient, and move out of intensive care. This analogy is important because if you’ve ever known someone who was in intensive care, the journey back to health is long and challenging. The economy became hooked on cheap money, and because of the inflation flare up, the Fed will have to move much faster than expected.

Next month, the Fed will stop buying bonds, which was a way of printing money, and is expected to begin increasing the fed funds rate. The fed funds rate is the overnight rate banks charge each other. It’s like the mother of all rates because it informs and influences everything from corporate bonds to car loans.

The market lives for expectations about what’s going to happen next. Last fall, the expectation was that the fed funds rate would increase 2 or 3 times this year. Each move is generally 0.25%. Inflation has become so wild that the expectation is now five to seven hikes this year.

For reasons I won’t bore you with, higher interest rates are generally the only way to tame inflation. For those of you old enough to remember, this was painfully, and successfully, demonstrated by Fed chair Paul Volcker in the 1980’s.

Now markets face a variety of challenges, which feed on one another. Just to give you a sense, here are a few of them:

• When interest rates go up, the price of bonds fall, hurting the “safer” side of portfolios
• When interest rates go up, stock prices tend to drop because it costs companies more to borrow, and new bonds at higher yields become tempting to investors when compared to stocks
• When interest rates go up, mortgage rates go up, making housing seem more expensive

The list goes on, but those examples really get to the point. It quickly becomes a sticky wicket for the Fed.

Rates will have to go up, and as you may have seen, this is already playing out in bond yields and mortgage rates. The Fed hasn’t actually done anything yet, but it’s ability to influence the markets is so strong that they move in anticipation. This also means the market agrees with the notion that the Fed has no choice other than to increase rates quickly, and begin vacuuming up the money it printed over the last two years.

The risk now: the Fed increases rates quickly to tame inflation, and ends up triggering a recession, or economic contraction. This has happened in the past, so it’s not a theoretical risk, it is very real.

Markets are constantly trying to look around corners, and into the future. While there is no expectation for a recession in 2022, there is now a real risk of one beginning next year.

What does all of this mean for our portfolios? While none of this is what investors want to hear, it’s not all bad news, and it’s a challenge all long term investors face from time to time.

Bond prices have dropped, but if you are: dollar cost averaging, reinvesting dividends, or both, you will be purchasing shares of bond funds at lower prices, and the new bonds in these funds will be issued at higher yields, which is good news for you long term. The other good news is that when a recession does come, and the Fed cuts rates, bond prices will rise, causing bonds to act as good ballast in what will be a storm.

Stocks have been overpriced for some time. While we don’t like to see stocks fall, we do like to see healthy valuations that make sense. Getting back to that point is better in the long run. And again, with dollar cost averaging, and dividend reinvestment you’ll end up purchasing stocks at lower prices, something long term investors love to do.

Those of us who plan to hold stocks for the rest of our lives, and will continue to buy along the way, don’t mind these ebbs and flows of the market. They present opportunities to buy what we love on the cheap, which is really ownership of the world’s largest economy.

If you have been speculating in stocks, day trading, buying what’s popular, and getting into the “meme stock” trend, it’s probably time to reconsider those positions and activities. The best way to invest in stocks for the long run is to purchase diverse, high quality portfolios, such as the S&P 500, with a plan to hold them for a long time.

These storms will come and go during our investing lives, they shouldn’t surprise us. While the pandemic economy was unusual, we’re seeing an economy and market returning to long-term norms in terms of growth, and it’s time for the Fed’s strong medicine to be withdrawn.

Even if there is a recession in the coming year or so, we should be prepared to weather that storm, and continue to grow our portfolios over the long run.

 

 

 

Buoyant Financial, LLC is a registered investment adviser located in Charlotte, NC. Buoyant Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. A copy of Buoyant Financial’s current written disclosure statement discussing Buoyant Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from Buoyant Financial upon written request. This note is for informational purposes only, and should not be construed as investment advice, or a recommendation to buy or sell securities.