The recession is coming, the recession is coming – or, maybe not.
Even as the market marches steadily higher, and the economic data print is consistently at or above the level indicating economic growth, the cry being heard is that a recession is coming.[i] Some even predict that the next downturn will be as severe as 2008.[ii] The pessimists’ rationale basically comes down to that old saying, “Trees don’t grow to the sky,” and the Fed always ruins the party just as it’s getting louder.
I gotta disagree! First, it’s really hard to forecast a recession. If it were possible, the Fed would head them off with a policy change. Second, recessions are kind of rare. Since, 1960 (a reasonable timeframe, as only 20% of the population is over age 60), there have been 8 recessions, with only 3 lasting longer than a year.
Remember, too, that recessions serve a purpose; they cut excess inventory and reduce labor markets, and generally shift expenditures from the private sector to the public sector. Unfortunately, recessions tend to correlate with bear markets in stocks, which destroy wealth for many. But recessions can be thought of like a system reboot: you might lose a little data, but when you’re back running, you’re faster and stronger. Similarly, as the economy recovers from a recession, the private sector takes over from the public sector, and the efficiencies gained during the downturn lead to growth in productivity. Accommodative monetary policy helps further accelerate growth, which is why every recession to date has been followed by larger expansions that take the economy to ever-increasing peaks.
The fact that we haven’t had a recession in a while heightens the expectation that we must be overdue for one. So when will the next one be? Is it different this time? How severe will it be? All good questions and worthy of some thought. Here’s my take.
First, things are different this time. In fact, they’re different every time, making change the only constant. But the differences this time around are more supportive of the economy than a threat.
The current economy is as diverse as I’ve ever seen or could have predicted. Across the economy, industries, sectors, and companies employ large numbers of people in jobs that did not exist a decade ago, when blockchain wasn’t a household word and “internet-of-things” wasn’t in the dictionary (Merriam-Webster added it in 2017). More capital is being deployed by private equity, venture capital, go-fund-me, and other “nonbank sources.” Evidence of this change can be seen in the S&P 500, with the debut of the new communications sector, combining the old telecom with media and broadcasting—think AT&T (which owns Time Warner) packaged with Netflix and Facebook.
Demographic changes are making an impact, too. Millennials, for example, are far less interested in home ownership, and are far more likely to use ride-sharing instead of owning a second (or even a first) vehicle. Given all these changes, I just don’t see the economy crashing down for the old reasons. Do you really think Uber will be impacted by Fed policy?
Having a contraction in more than half the sectors that make up the economy and the employment picture is more difficult today than when the U.S. economy was largely dominated by manufacturing. “What is good for General Motors is good for our country” was once the conventional wisdom. Not anymore.
Wealth is being created in new and sometimes previously unknown sectors. Who would have predicted the impact of the iPhone at its debut in 2007, or cloud computing, which become commercially available starting around 2006? (Thomas Friedman has called the cloud one of the world’s most important technology developments) and this was on the heels of the “great recession.”
The changes in the economy are also systemic. There’s an argument to be made that, after so much wealth was destroyed in the financial crisis and the deep recession that followed (more than $34 trillion of wealth lost globally by March 2009), the “powers that be” have engineered a low-growth environment that’s meant to be long-lasting. As I’ve been saying all along, having made it to the other side of the great recession, we are in for a very long recovery.
The boom/bust cycle has been altered: shorter, shallower recessions and longer-lasting expansions. In between, the economy reallocates, redefines, and grows. Changes in the economy have effectively “cut off the tails” at both extremes of the distribution curve. That means recessions will probably be fewer in number and less severe—and with less traumatic impact on the human psyche. But the tradeoffs are more subdued returns and growth.
In this new world, low/no risk of government bonds I expect will pay 1-3 percent per year. Taking on a little more risk, such as with high-grade corporate bonds, I suggest could produce a return of about 3-6 percent annually. In return for even more risk and a higher degree of volatility, equities can produce an average annual return of 8-12 percent. And all available in easy to invest and easy to understand instruments that you can buy in your 401(k). The point here is that investors are more educated and mindful of risks and returns. Tools and policies have been created and implemented to control risk. While passive investing has been a benefactor of this phenomenon it also has created challenges, Therefore the need for active management is essential to a complete portfolio.
Over the course of expansions and bull markets, flat or even negative returns are common. While the economic data, indicate the current expansion still has room to continue, flat or down periods would not be unusual. No one can successfully time corrections, and that includes me (we’re not in the business of market timing). However, our proprietary Astor Economic Index (AEI) shows stocks have more room to appreciate before this expansion ends. How it gets there is anyone’s guess. Active investing—which I sum up as “stocks when you want them; bonds when you need ‘em”—can make for a smoother ride.
So, is a recession coming? Probably, at some undetermined point in the future, although I think it’s neither wise nor possible to say precisely when. We haven’t eliminated recessions from the economic cycle any more than we’ve cured the common cold. But there are plenty of things you can take to make colds shorter in duration and less likely to turn into pneumonia.
The same can be said for recessions. A downturn might bring on the sniffles (worse for some than others) but nobody’s headed to the ICU.
Coming soon… economic distribution of scarce resources.
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The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data.
[i] Jeff Kearns, “Two-Thirds of U.S. Business Economists See Recession by End-2020, Bloomberg. https://www.bloomberg.com/news/articles/2018-10-01/two-thirds-of-u-s-business-economists-see-recession-by-end-2020
[ii] Michael Selby-Green, “A Spike in 10-Year Treasury Yields Could Trigger a Financial Crisis to Rival the Great Depression,” Business Insider. https://www.businessinsider.com/martin-feldstein-treasury-yields-financial-crisis-great-depression-2018-9