Recession and Stock Prices

Recession chatter has been picking up in recent days, we have noticed। We expect this trend to continue. Professor Martin Feldstein's grave recession warning, as well as dire predictions about the severity of the forthcoming decline in house prices by two other eminent economists at the FED's annual Jackson Hole clambake, have legitimated recession worry. In one respect this is an improvement over the previous stifling atmosphere of FED-orchestrated nonsense about endless economic growth in the face of deteriorating consumer fundamentals. The recession talk does bring an element of realism to what has hitherto been a tedious reiteration of wishful thinking which lacked any relationship to reality. For investors, however, the forthcoming round of recession alarms is more likely to generate confusion, heat, and mindless fear, rather than produce any slivers of enlightenment.

What can we realistically say about relationship between recession chatter and the actual risks of same? That's an easy one। There is NO RELATIONSHIP WHATSOEVER. Typically, popular awareness of any trend grows the longer the trend is in place and the closer it gets to the peak and the accompanying POINT OF REVERSAL. This is no different for the economics fraternity than for the generality of public opinion. Ergo, the more widespread the recession chatter, the less it tells us about the future. It does, however, tell us quite a bit about what has ALREADY OCCURRED. The obvious point here is that the yield curve inversion which occurred more than a year ago was an unmistakable and INDISPUTABLE early warning signal of a forthcoming period of economic weakness. Despite the endless dissing of the curve's predictive power by such notable lights as Mr. Greenspan and Dr. Bernanke, duly echoed by their horde of camp-followers in banking, finance, and the media, the inversion demonstrated once again its virtually infallible predictive capability. The economy did indeed slow to a crawl. Whether or not it would fit the technical definition of recession -- of which there are many -- is neither here nor there. The economy experienced stagnation, with some sectors in clear (and deepening) recession, while others continued merrily along their way. We must note that none of the ECONOMIC SAGES took appropriate note of the inversion's significance when it occurred or for many months thereafter. They were too busy outdoing one another with predictions of how much growth was ahead.

Does this mean that economists are always wrong? Well....if you haven't got something nice to say, maybe it's more polite not to say anything at all। The economics confraternity, like most of us, seems to conform rather nicely to the laws of herd behaivor.

One important consideration in assessing recession's likely impact on stock prices is to pay due respect to the reality that there are recessions and there are RECESSIONS। Dr. Feldstein, for example, seemed to us to be alluding to the possibility of a BIG RECESSION. Do we think he was wrong? No, not at all. As we have been saying all along, there is the real possibility of something much worse than even a bad recession if the FED persists in its erroneous ways, viz., a DEPRESSION. (However, we remain optimistic that we shall avert this nightmare).

To return to the issue at hand: what is the impact of recession on stock prices? The answer is: VARIABLE। Recessions can be good, bad, or irrelevant re. the level and direction of stock prices. Everything depends upon the relative strength of the two components of every recession which impact stock prices: falling earnings, and falling interest rates.

During recessions, both decline। The key question is: where is the relative decline greater? If interest rates decline more than earnings, the multiple expansion which occurs re. stock prices will more than outweigh the actual diminution of earnings, leading to higher stock prices. If the opposite is the case, then the consequences will be negative. Stock valuations, of course, are a function of the company's earnings AND the price/earnings multiple the market accords those earnings. When interest rates fall and bond yields drop, stocks become relatively more attractive. The two asset classes are locked in perpetual competition for investors' money, and lower interest rates reduce the appeal of bonds.

There is also the issue of the different impact on different segments of the economy of the reduction in economic activity which is the hallmark of recession। Some sectors and individual companies fare badly; others are relatively unscathed, or not even touched at all. Stocks in this latter category gain an extra measure of attractiveness in this environment, enabling a more substantial multiple expansion. In today's global, greying environment, healthcare, Asia-oriented, energy, and technology stand out. Anything in the real estate/financial/consumer nexus should be labelled: RAT POISON!

We can now expect a tidal wave of dire economic forecasts and of fear-mongering pronunciamentos of impending collapses, crashes, bear markets, etc। The only beneficiaries of this outpouring will be those who receive salaries for filing copy, for generating transactions, or gain fees for "advice." The soundest response, we think, is stopping our ears lest we be influenced by this imminent ocean of drivel. We feel that we are on pretty solid ground in suggesting that you will NEVER, EVER receive any practically useful advice from the financial media, and precious little from the "investment community." Many will exploit fear and greed, because fear and greed always SELL.

The future course of the economy -- for those who are interested in this topic -- will turn upon the decisions of the central bank। Unfortunately, this institution has virtually unchecked power। It has, to borrow from Mr. Chief Justice John Marshall's famous ruling ("The power to tax is the power to destroy"), the power to wreak unimaginable havoc. Alternatively, if it acts with speed and wisdom, it can save us from ourselves, and save us from ITS PREVIOUS ERRORS.

For equity investors, the course of wisdom is to seek individual securities which provide solid value at reasonable price. There are almost always such stocks available, no matter how stormy the skies. However, to find them, one must not only search hard, but one must be willing to buy the most unloved, unpopular, and unwanted stepchildren of the equity market.