Daily Update: Recession Is Inevitable (But Not Here Yet)

It turns out that some of the most prominent people calling for a recession got more attention than they wanted. The market priced in a worst case scenario yesterday, which is part of why it’s bounced back a little today.

Granted, there’s a lot of damage left to recover. And a lot of key companies are still facing recession-like prospects. Big Retail is warning us that consumers are starting to bend buying patterns under inflationary pressure.

But that’s exactly what the Fed wants to do. Stopping the flow of free money forces us all to be more careful about what we buy and when we buy it. Demand steps back. And when demand weakens, suppliers get a chance to catch their breath.

When supply catches up with demand, prices stabilize. In theory, they might eventually come down when supply exceeds demand. For now, however, the Fed will accept simply getting prices under control.

That means forcing something like a recession . . . a slowdown. Investors who came of age in the past few decades may not believe it, but once upon a time slowdowns were considered a necessary phase in a healthy economic cycle.

For most of American history, we hit a recession about once every three years. The past few decades have been exceptionally good, with much longer periods between significant slowdowns . . . but the dips, when they come, have been severe enough to leave long-term marks on investor psychology.

We all remember the COVID shock, as brief as it was. Most of us also have a pretty good sense of how awful the 2008 crash was, severe enough after a six-year expansion that we called it the “great” recession.

Then you go back to the double punch of the dot-com collapse and 911, which was so serious that the job market took until 2003 to bottom out and Wall Street needed four more years beyond that to bring back the bull.

Each of these recessions scared and scarred investors for years afterward. The Fed and other players in Washington have learned to watch the economy extremely carefully. If they can keep the market stimulated for another few months or even years, they’ll cheerfully do what it takes.

But my point here is that if you’re selling stocks now because someone like Goldman Sachs told you there’s a 35% chance of a recession in the next two years, you’re going to miss out on a lot of market history trying to steer clear of the slowdowns.

Say the smart kids at Goldman decided the recession odds were 100% in the next 24 months. We’re now 25 months into the post-COVID expansion, so that means we have at most four years. If you don’t want to be in the market when the economy turns, you might have to sit on the sidelines until mid-2024.

You’ve lost up to two years in the cycle in that scenario. None of us get an endless number of two-year breaks in our investment careers. Most of us try to make the best of every single day.

When the market as a whole goes sideways and buy-and-hold strategies stall, we pivot to more active trading approaches. Buy low, sell high, repeat as needed.

If most stocks are going down, buy puts that make money on the downside. Buy inverse ETFs that go in the opposite direction of the underlying securities. And you can always simply crowd into the “lifeboats” the market always provides, the relatively safe havens that keep cash flowing throughout the economic cycle.

But while selling two years ahead of even an assured slowdown eliminates all the risk, it also cheats you out of all of those opportunities. You’re stuck with cash or, at best, bonds. Guess what? Neither is keeping up with inflation right now . . . and every time the Fed raises rates, bond prices need to come down to compensate, which makes them depreciating assets.

And the 100% recession scenario assumes that the Fed has lost control and that we’ve left the relatively easy world of 1990-2020 behind. Recessions might become more frequent. The good times might get shorter.

That’s the bear mindset, right? So if we’re back in the pre-1990 world, that means the average expansion from here might last about 3 years. Statistically, we’d never be more than about 36 months from the next recession.

In that event, folding your hand as much as 24 months from the next recession call cheats you out of 65% of your entire lifetime as an investor. And that is madness. We didn’t do that in the 1980s. We traded the market we had, day by day and year by year.

We’ll talk more about this tomorrow. But here’s the real takeaway:  Goldman itself says the market is pricing 100% recession odds in the immediate future. The firm with the big bear call says negativity has gotten out of control.

In that scenario, when stocks are priced for the end of the world and the world doesn’t end . . . what happens to people who buy the stocks? Warren Buffett says it best, get greedy when everyone else is fearful.