Economic Storm Or Better Opportunities Than We’ve Seen In A Long Time?
Investment Perspectives: Q2, 2022
Chief Executive Officer, Founder
Todd Sixt is the CEO of Strait & Sound. He is a successful and seasoned leader of financial service teams. His focus is to ensure Strait & Sound’s clients are provided with a first-class experience and that the work delivered by our people is unsurpassed in the financial services industry. At his core, he believes in excellence.
That being said, I believe we are headed into a mixed market, one where certain sectors of the economy will experience a rough ride. But other sectors will fare quite well. More than anything, I believe that long-term investors, those with a healthy attitude toward risk, need to be visionary right now. This is not a time for panic nor a time to sell. This is a time to be wise, to be patient and, quite possibly, to carefully identify opportunities that are most definitely out there. Here are my perspectives on the state of the U.S. economy in Q2, 2022.
What’s Happening Right Now?
It’s a challenging time to be an investor right now. I’ll admit that straightaway. What’s making it challenging?
- The Fed Chairman recently raised interest rates by 75 basis points. This means borrowing just got more expensive, especially for mortgages.
- Inflation is at an all-time-high, at least for most of us working adults. Most of us have not seen inflation rates like this since we were children.
- The mid-term elections are just ahead and they come with a degree of uncertainty. Politics have routinely impacted the economy.
- Omicron specifically, and COVID more generally, are still having an impact and are still a perceived threat, even if the actual threats might be greatly reduced.
- The pain at the pump is very real, especially for people who drive a lot. As I write this, oil just crossed over $119 a barrel.
- Supply lines are still being impacted, which is making it hard for manufacturers to predictably develop and market their products. It’s now common to see empty shelves where we used to see products we’d buy every day.
- The war in Ukraine is still raging. Ukraine’s ability to export grain will be heavily impacted by this. Buying Russian oil is a hot-button issue for fear that it will undercut the effects of sanctions.
- The stock market has dipped. On January 4 of 2022, the Dow Jones Industrial average clocked in at 36,799. On June 16, it clocked in at 29,927, representing a 19% loss. Some investors are reporting losses higher than that.
So does all of this bad news automatically guarantee that we’re heading into a recession? Before I offer my perspectives on that topic, I think it’s important to get the definition of the term right. To a lot of people, the word recession means a bad economy, joblessness, high interest rates, out-of-control inflation and a feeling in the pit of your stomach that things are just not going well. That’s not really what recession means.
What, Exactly, Is A Recession?
I’m sure this will be cold comfort to anyone who’s concerned about a recession. But just so we’re all operating on the same assumptions, here is the technical definition of a recession.
A recession is marked by two consecutive quarters of declining GDP as documented by The National Bureau of Economic Research.
A better way to think about a recession is that it represents a temporary slowing of growth. It tends to cool off a red-hot market. It’s sort of like the economy catching a cold. When economists talk about a coming storm, it tends to make people duck for cover. I think that’s something of a mistake. A storm might be a category 5 hurricane. Then again, it just might be a rainstorm, the kind that helps everything grow.
When economists use the word recession, my concern is that people tend to hear the word depression. So, I think it’s important to distinguish between them. If a recession is a decline in GDP over two consecutive quarters, a depression is far worse than that. While there may not be a formal definition of the word that all economists will agree to, in general, a depression means an extreme fall in economic activity that lasts for years. The U.S. Great Depression in the 1930s is a classic example.
So let me say this for the record. It is entirely possible we may be in a recession right now. But the likelihood that this will turn into a depression, at least in my mind, is very small. Why do I say this?
- Corporate earnings are strong and could remain strong through the balance of this year.
- Employment is also strong, although job growth appears to be leveling out.
- The war in Ukraine will likely continue to impact grain and oil prices. But if Ukraine wins or if they come to a significant cease-fire, the economy could rebound quickly.
- Irrational exuberance has been knocked out of the market and that’s a good thing. It protects us from irrational crashes and even further volatility.
- The mid-term elections could make things much clearer politically. My sense is that we all pretty much know the economic tendencies of both Democrats and Republicans. It could actually help the economy if one party became dominant because their economic policies could be enacted much more quickly and without turmoil or resistance from the other party.
- Some technical indicators are turning. For example, sentiment has swung back to value stocks as relative strength indicators are near previous bottom levels and likely to turn favorable. The S&P 500 relative strength index is hovering at about 20 right now. When things are getting oversold, the index has usually been closer to 30. In other words, it appears to me that there is opportunity here..
This is why I think it’s important to keep in mind a crucial concept. Recessions and even depressions end. So the question I think we should all be asking ourselves is this. How will I be positioned for the economic rebound that is likely to come on the other side? That, my friends, is how I encourage you to think about where we are now. The reason I say this is two-fold:
- Doing nothing during a period of economic decline is usually not a bad idea. This is pretty much what my last article prescribed. A rising tide lifts all boats and those who stay in the markets during the storm will be well positioned to rise with the recovery after the storm.
- For a select few brave individuals with a tolerance for risk, this could just be the ideal opportunity to make moves that will propel them forward, once the rebound that we all know is coming gets here.
Key Take Away
“For a select few brave individuals with a tolerance for risk, this could be the ideal opportunity to make moves that will propel them forward, once the rebound that we all know is coming gets here.”
What Do I Recommend Right Now?
Given everything I’ve said above, I do have four recommendations:
- Avoid long-term debt right now, if possible.
- Make sure your risk tolerance is properly represented in your diversification strategy.
- For those who have the cash and the risk tolerance, this could be a great time to buy.
- Remember that this too shall pass.
Avoiding long-term debt right now is a good idea. The most significant form of long-term debt that most people consider is real estate. At the time of writing this article, 30-year fixed interest rates on primary mortgages have jumped from around 3% at the start of the year to around 6% today. This means that buying a secondary vacation home right now may not be the best idea.
Let’s talk about diversification for just a moment. Some people think that they’re diversified because they own stock in the top 10-to-15 U.S. based companies. That’s not what I mean by diversification. For me, there are four primary ways to diversify:
- Stocks. As my analysis above indicates, these could recover quickly, given the right conditions. We could see turn-arounds in stock prices by as early as Q1 or Q2 of 2023. But then again, stocks may take several more quarters to recover in value to their previous highs.
- Bonds. These are likely going to take much longer to recover. Real bond rates are negative or break-even right now. They remain a solid opportunity only for those with a long-term perspective.
- Cash. I’m sure you know the old saying that cash is king. My sense is that you need to have enough cash reserves in ready-to-access accounts equal to six months of living expenses.
- Assets. The most significant non-investable asset that most of my clients own is real estate: usually a primary home, a secondary vacation home or even commercial real estate.
So when you look at these four asset classes, how does your diversification strategy stack up? Are you balanced across all four of these in ways that align with your risk tolerances? When the markets course correct, I often find that risk tolerances go down. People get that feeling in the pit of their stomach that they’re about to lose a lot of net worth. Usually this happens because they’re unbalanced in their risk tolerances. It sometimes takes a course correction for people to realize that they’ve taken on more risk than they ever really wanted to.
Now let’s look at opportunities to buy. I actually do believe that this is a good time to buy for those with cash and a willingness to take risk. Smart investors look at the fundamentals. For me, P/E ratios (price-earnings ratio) are one of the truest indicators of a company’s financial strength. A business’s P/E ratio is factored by dividing their share price by their earnings per share. You can then compare the current P/E ratio to a historical norm. A higher P/E ratio then normal is not a very good time to buy. Currently, valuations measured by the P/E ratios are much lower than the last few years and again indicate this is a better time to be buying.
There are several industry sectors we’re tracking right now that look attractive. For instance, in the finance and banking sector, a few institutions have P/E ratios in the single digits—something we haven’t seen in a long time. But it’s not just banking. Several big tech stocks are more affordable now than they’ve been in many years. The healthcare and bio tech sectors are also showing favorable opportunities. I’m not suggesting that you should buy stocks in these sectors. But I am saying that if the situation is right for you to buy, these sectors are showing a better relative value than the market has offered in a few years.
Finally, I want to remind you that this too shall pass. We’ve seen periods of expansion and contraction before. They don’t last. That’s why my advice has been that time-in-market beats trying to time-the-market. The markets are simply too unpredictable to try to perfectly time. Most people who do that end up with regrets.
I also want to leave you with this parting thought. Market corrections are actually a good thing because they remind you about what’s really important in life. My wife and children, our home, our health, time with friends and family—these are the things that really matter to me. I would imagine you feel the same way.
Our goal is to protect and grow our client’s wealth so they can live a life free of financial worries. So if the current market is eroding your peace of mind, if it’s causing you undue stress, maybe it’s time we took a look at your risk tolerances? If you feel like you need that, please know that our doors are open.
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