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Observations on the Market //

The Market Can’t Be Clear and Sunny Every Day, but Eventually the Storm Will Pass.

Written by Greg Denewiler, CFA® // July 21, 2022

There is a saying in Colorado that if you wait a few hours, the weather will change. The markets must be experiencing a rocky mountain high because sentiment seems to change every few hours as to whether we are in a recession or not. How bad is it about to become? When will inflation subside? It is easy to get caught up in the drama because the outcome can affect your investments and potentially your lifestyle. However, it is also good to keep the economy in perspective and realize there are a lot of moving parts. The economy is constantly evolving as to what affects what, which is why predicting it is far from a science, and more an art form.

 

 

Let us first look at past recessions and their effect on the economy. The chart below shows that the average recession has a duration of 12 months. If you exclude The Great Depression of 1929, they are on average 11 months. Since 1949 the impact of a recession on GDP has become much less dramatic. The 70-year average is a decline in GDP of -2.3% (excluding 2020 when the economy was artificially forced to close). Why do recessions have less impact on GDP nowadays? This is partly due to government spending which is now up to 17% of the economy. A recession’s impact on corporate earnings is more pronounced than on GDP due to consumer spending and corporate investment being more discretionary. The takeaway from the chart is that recessions come and go but are usually over by the time we realize we are even in one. The stock market is always trying to anticipate the future and historically begins to recover six to twelve months before the recession is over. This leaves us with the question – if recessions are usually over before the year finishes, why such a big reaction in the market today?

Table of US recessions and their duration with associated GDP declines

 

Numerous books have been written on the topic. Investors are emotional and are inclined to get greedy when times are good and become too fearful when things go south. Every recession has a different cause and cure, and they all look scary when you are in them. We never know how long they will last, or when investors are going to turn from pessimists to optimists. It ultimately takes an element of faith. If you were unlucky enough to have invested right at the top of the market in September of 2007 and held for the next 15 years, a $10,000 investment in the S&P 500 is now worth $36,000. This is after the recent 20% decline in the market. If you happened to buy at the bottom in March 2009, $10,000 is now $70,000. Most investors fall somewhere in the middle, but with patience, the rewards are substantial, even if you are ‘unlucky’.

 

 

There are plenty of reasons to be concerned about how our debt and inflation issues will become resolved, but the news is not all bad. The Brookings Institution estimates that by 2030 1.4 billion people will enter the middle-class economic sector from China, India, and Southeast Asia. Now consider that the companies in the S&P 500 currently produce almost half of their revenue from outside the US. The global consumer seems to have some appetite for western culture and lifestyle. It is not too hard to suggest that even though our economy may not be great in the short term, the stock market still has reasons to grow in the next decade. We as US investors have only experienced an economy that has dominated global commerce. That appears to be changing. It’s not that we are declining, it’s just they are about to have a middle class that is at least twice as large as ours. What are all the implications? Nobody knows. One thing is clear, the global consumer appears to like American stuff, so, American companies will probably benefit in some way. Recessions clean out ‘most’ of the excesses that build up during an expansion cycle and are ultimately good just like winter is necessary for the new growth of spring. You can’t predict how bad winter will be, you just know eventually it will end. The problem is that everyone thinks they are great forecasters, but just like predicting the snow in Denver, they are usually wrong, or at the very least the snow eventually melts.

Observations On The Market No.373