Your Recession Guide For 2022
Almost exactly a month ago, our team released a “News or Noise” YouTube video titled “Negative first quarter 2021 GDP Growth, Is a recession coming?” We did this video because on April 29th, the Commerce Department, which is the government agency that calculates this data, released first quarter real GDP growth figures saying our economy actually shrunk by -1.4% in the first quarter, versus economist expectations of a positive +1%. We figured that this would kick off the non-stop media discussion of whether we would have a recession in 2022 or 2023 or ever again.
I am Chris Perras with Oak Harvest Financial in Houston and welcome to our weekly stock talk podcast. Before we get into this week’s topic on the recessions and the stock markets, please take a moment to click on the subscribe button and click on the notification bell so you will be alerted when our team uploads our latest content.
This week’s topic is to help address the ongoing headline stories of a weak economy, negative GDP growth in the first quarter, or a looming recession.
First off, I will continue to remind investors that government data is reported late, is often revised multiple times, and is almost never predictive to the economy or stocks. Think about it, by the time that negative GDP quarter was reported in late April, the S&P500 was already down over 14% from its December all-time high and sitting around 4135. Conversely, by the time the data scientists in government declare a “recession”, most of the time, the markets have discounted most if not all of the bad news, have healed to a large degree, and recovered much if not all of their losses as they are already looking forward to the next 12 months and easy comparisons in growth rates.
Our prior podcast walked through how GDP growth is calculated. In it we detailed how the surge in import volumes in first quarter of this year led to our negative GDP print. We also discussed how terribly difficult the first three quarter of 2022 comparable GDP numbers would be. Recall that in the first half of 2021 our economy was still being aggressively pushed forward by government spending which is called fiscal policy, and monetary policy expansion helped by the Federal Reserve. Throughout the first 2 or 3 quarters of 2022, we have to comp against the “sugar high” induced GDP rebound in 2021. Here is a table of GDP growth the last 2+ years.
I focus on this GDP data now, only because the financial industry and news outlets have come to define a recession as two or more consecutive quarters of a declines in real GDP. Even though it was oddly manufactured, we have technically had one negative GDP quarter, so the doomsdayers are out in mass. I’ll share the data I have on stock markets and recessions, but I want to follow it up with more data on bear markets, how often they occur and how we often recover quite quickly from these events. So here goes.
I am not going to throw some guestimate out there on the odds of a recession. We either will have one or wont and giving odds of 25%,35%, or 50% seems silly and impossible.
Since World War 2, we have sustained 12 recessions. The median decline in the S&P500 was 24% and the average was about 30%. The median decline would place the S&P500 low tick around 3600 or only 5-6% below the lows of last week. Remember, the S&P500 was already down almost 15% before the first negative quarter was printed at the end of April. Remember, equities indexes tend to discount both good and bad news in advance.
Across those same 12 recessions the equity market has peaked on average 7 months before the official start of the recession per the NBER’s designations. The average peak to trough market timing has averaged about 13 months, however, it’s been as short as one month on 2 occasions and as long at 30 months in the case of the 2000 post dot.com and Y2k bubble collapse.
As for valuation, the S&P forward P/E multiple has dropped by a median of 21% from its prerecession peak to its eventual trough. For our current market, the S&P500 forward P/E peaked over 30x earnings in late 4th quarter 2020 and early 2021 and it now sits around 16 times earnings. That’s approaching a 40% decline. Even if analysts were late to raise numbers post covid, the market appears to already have already discounted a lot of bad earnings revisions for the 2nd half of 2022.
Here’s the PE chart from Goldman Sachs for those who want to see it with their own eyes.
Yes, inflation is running higher than the last 20 years, however overall interest rates still sit materially lower than other times during the last 20 years and real time inflation rates look to have peaked 4 to 6 weeks ago. Equity Prices have declined, which is making stocks more attractive on a valuation basis, however yes, there is still earnings risk to summer.
Over the last few weeks, we’ve laid out the historic stats on corrections and bear markets and recoveries. We’ve given you the stats on depth and time for recoveries in cycles past. Instead of rehashing those data series, I want to leave you with four positive stats to think about. One purely historical data point and then 3 others which are follow ups to our “things that lead” which we laid out last November. These data series, all having to do with the treasury markets, are slowly inflecting positively now just as all the doomsday calls get louder. All of these series have pointed to stabilizing and then higher stock prices over future months and quarters in the past should these trends continue.
First a lot has been made about the last 7 weeks being only the 4th time the SP500 has been down 7 weeks in a row. Those prior three dates were 1st half 1970, first half 1980 and the first half 2001. In all three cases the forward return on the s&P500 was positive and in both the 1970 and 1980 cases, the 1 year forward return was almost exactly the same, just over 33%. I find that interesting as it is a huge greater than +30% one year return number. This sized number keeps showing up a lot in history during strong runs off market lows and pivots. Don’t believe me?
Did you forget the President Obama re-election 2012 market rally? Yes, the market gained over 35% the next 13 months. How about the President Donald Trump election rally? The market gained over 35% the next 13 months. And most recently, did you forget about the 2020 Biden Presidential election rally when the market gained over 35% over the next 13 months as well. The market seems to like to surprise to the upside when most people are fearful. And no, the last 12 years, it hasn’t dependent who was running the country.
As for the real time bond data series that behind the scenes seem to be easing, here they are. First off, real-time inflation expectations look to have peaked weeks ago. We have discussed this a few times. It’s been a great leading indicator. The 10-year inflation expectation peaked over 3% in late April and May and has now dropped about 50basis points or ½ of a percent. I know it isn’t the often-quoted government CPI data, however this data series is real time and market priced. It isn’t months old government data that constantly gets revised.
The second and probably even more important bond market data series that looks to have peaked and rolled over is the “real interest rate” component of Treasuries yields. This is commonly referred to as the “real rate”. This looks to have peaked on May 10-12th not coincidentally when the SP500 made its recent lows.
What makes this so important is it is one of the inputs that many investors use to calculate the Equity risk premium. The equity risk premium is the excess return earned by an investor when they invest in the stock market over a risk-free rate. This return compensates investors for taking on the higher risk of equity investing.
Here is a chart of that 10-year real yield. My guess is you will not see this chart or hear about this stat on TV but it is extremely important if you want equities to stabilize and move higher. It is Particularly important to high growth stocks and technology focused stocks.
Look at this chart for a few seconds. See where the big circle is located? Early January of this year? Do you recall when the S&P500 and tech stocks started their accelerated declines? Yeap, spot on at the exact same time. Now look at the chart last week. Yes, that looks like a peak in the “real rate component” of interest rates and that its broken its sharp upturn that has lasted most of the year. If I was running a hedge fund, which we are not at Oak Harvest, and if I had been negative or bearish on the markets year to date, or sitting in a lot of short positions, this indicator screams to me to cover shorts and look for a very strong rally. Apparently someone else noticed it almost exactly 1 week ago as well given the markets strong move the last week.
Early signs of optimism? It looks that way. That’s what seems to be lurking behind the scenes in many of the same charts that caused us to pen our first half outlook in 2022 titled “curb your enthusiasm” back in November. This time, opposite 6 months ago, many of these same indicators are leaning toward saying that amongst all the bad news and slowing data, the markets are looking to find their footing and rally in the coming months.
Our team here at Oak Harvest knows that the last 5 months has been a trying time for those in the equity markets who are not trading oriented. The sustained higher market volatility for the first time in over two years is a harsh reminder to investors that stocks do not always go up. They certainly do not always go up in straight lines with low volatility. And there are no guarantees in the public equity markets. We know these sharp market moves tend to create emotional angst and the urge to make changes to what are supposed to be longer term asset allocations.
If the ongoing market volatility is making you feel uneasy, I would ask you to give us a call and schedule a meeting with an Oak Harvest advisor. Our team does have insurance-based tools in our planning toolbox that do not have the volatility of public equities. However, I remind you, that these investments will also have lower expected long term returns for your savings.
Give our team a call before making any dramatic changes to your allocation during times of heightened market volatility. These types of long-term asset allocation changes are usually best done when markets are calmer and one’s emotions are less elevated.
At Oak harvest, we think our clients are best served by us helping them plan for their future needs, instead of focusing on the past. The future is always uncertain and that is why our advisors and retirement planning teams plan for your retirement needs first, and your greed’s second.
Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals. Call us here at 281-822-1350, and schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.