Wall Street is infamous for predicting endless economic downturns that might kill the mood at billionaire investment banks but leave most Americans waiting for a storm that never really comes. That’s what happened last year.
So if the past wasn’t as catastrophic as predicted, it’s no surprise to see stocks rebound in relief. The economy dodged a big bullet and a big wall of worry fell down. The question, of course, is whether the market can get what it needs this year to parlay that relief rally into something bigger and brighter for all of us.
The Fever That Felt Like A Crash
Through all the sound and fury around the Fed, interest rates, the housing market and universal pain at the supermarket and gas station, the U.S. economy ended 2022 close to 3% bigger in real, purchasing-power-adjusted terms.
Don’t get me wrong. Last year was miserable for a lot of people who worked harder than ever and felt poorer despite all the effort. That’s what inflation does. It makes what would otherwise be a comfortable level of heat in the economy feel like a chill.
Wall Street and Silicon Valley have the chill. Corporate earnings are down a few percentage points, especially for the banks and Big Tech. Main Street hasn’t officially caught the bug . . . yet.
Granted, the price of everything is still climbing at a 3.2% annualized rate. But real disposable income kept up . . . and in all in all, when the economy expands faster than the buying power of your dollars shrinks, arguing that the country as a whole has stalled takes some rhetorical gymnastics.
Admittedly, a chill on Wall Street and a chill in Silicon Valley are tough for the rest of us to shake off. There’s nothing to stop layoffs at Amazon and Microsoft from spilling over into brick-and-mortar companies if things get worse.
However, those layoffs just haven’t happened yet. There’s a simple reason: companies that fought to keep workers and hire new ones are extremely unwilling to let go of them now. Job listings haven’t evaporated.
Many blue-chip companies are still desperate for people to fill the desks of those who quit in the pandemic. Their need isn’t even about aggressive expansion plans. It’s about filling existing vacancies to make sure existing work gets done.
And if there’s no mass layoff brewing to rival the 2008 crash, it’s hard to say we’re in the kind of recession that will shock working households to stop spending. People are still making their debt payments. American Express recently said it sees no recession signals at all in its account books.
So if the consumer recession so far has been mild, the real threat shifts from Main Street to Wall Street. Households have done okay so far. Savings rates are even going back up as the pandemic recedes.
Investors can breathe a sigh of relief that our end of the economy didn’t break down either. We evaluate the economy by what it does to our favorite companies . . . when you’re a shareholder, every dip in earnings is a “recession” as far as you’re concerned.
On that basis, we know for a fact that last year wasn’t catastrophic at all. Earnings are tracking 4% above 2021 levels and a long way from where they were in pre-COVID times. And as we’re learning now, all the accumulated drag only took earnings down 4% last quarter compared to where they were a year ago.
It was a great year for oil companies, obviously. But there was no corporate recession for the airlines . . . or Tesla . . . or other industrial conglomerates . . . or landlords . . . or utility operators.
Healthcare and technology companies aren’t growing fast (which is a problem for Silicon Valley, where stocks factor in eternal expansion) but they’re still outperforming the economy as a whole. There’s no recession there either. We might not love the stocks, but the companies are doing just fine.
The pain is concentrated around retail companies, from Amazon on down, as well as their cousins in the social media group. And the banks are making 18% less money than they did at the end of 2021. That’s ominous. If you’re looking for the chill, that’s where it is.
And if you’re nervous about the economy, these probably aren’t the companies you want to own right now That’s where a tangible recession is playing out at the sector level. Other areas of the market might get a softer landing or avoid any kind of year-over-year deterioration . . . and that’s where nervous investors want to be.
A Cliff Or A Stumble?
Of course investors tend to look past the present, which free markets tend to price fairly accurately into asset prices. We’re all about what these stocks will be worth tomorrow, which means having a sense of where the economic winds will blow around them.
This is why guidance has been so important this season. The past is dead. Being in position for the future requires us to pay attention to what executives are seeing in the here and now.
For the market as a whole, the big money is already braced for another six months ahead that could feel a lot like what we just lived through last quarter. All the best brains on Wall Street put together think that earnings will drop 2-3% in 1Q and 2Q, which isn’t great but it’s far from apocalyptic.
The concern around that minor drag isn’t whether companies can survive with “only” 97-98% of their 2022 cash flow. It’s not like we’re forecasting operating losses. The status quo looks endlessly sustainable . . . just not great.
In the current quarter, it’s looking like Amazon will rejoin Tesla as growth engines for the consumer sector, but otherwise there just isn’t a lot of cheer. You’re allowed to ignore companies that aren’t doing well. Unless a retailer is changing the world, feel free to skip it.
But stick to energy and the airlines. And go long on the REITs if you’re looking for a recession-proof haven. Barring a profound economic collapse, it’s usually good to be the landlord . . . and these companies are required to pass on most of their profit to shareholders. What could be better?
The banks should bounce back a little. They’ve already taken their tough medicine and are now prepared for whatever economic storms are coming in the next six months. Otherwise, it’s looking like a soft quarter ahead, without a lot of clear winners beyond the themes I’ve mentioned.
If you’re looking for a recession on the calendar, guidance says the odds are good that for most companies, it’s happening now. This is it.
And this is as bad as executive outlooks get for the coming year. After this, one way or another, the environment gets more constructive for sector after sector. What they’re seeing is that the pain of the last few months is transitory, not systemic.
One or two CEOs could be wrong. But all of them? It’s unlikely. We’d need to see a big external shock to knock our targets much lower.
The Bottom Line
A good investor should be able to sit through 3-6 months waiting for favorite companies to get back to work. We’ve already gritted our way through a year-long bear market . . . and most of that was in the face of positive earnings, no recession whatsoever from a corporate perspective.
We can blame the Fed. But the Fed’s going to be done soon. Their favorite inflation gauge is already back below 4% a year and as the Ukraine war drags on, year-over-year energy costs have largely plateaued.
Now some smart people in the market know they can wait a few months for gratification. They’ll buy early and ride out any short-term storms.
Isn’t that what investing is theoretically all about? You reach for big returns even though the odds of success aren’t absolute. A lot could go wrong in the world. You could lose money.
But when people are willing to swallow a little volatility in the short term, we tend to do okay in the longer haul. That’s American history. For generations, stocks have paid shareholders back 8-11% a year over time.
Individual years have been better. They’ve also been a whole lot worse. But hang in there for a few years and the index funds will tend to converge on that simple statistical truth.
Think of that 8-11% as the reward for courage or at least stubbornness. Now if you add insight . . . and experience . . . and a little luck to that courage, you can squeeze a better outcome out of the cycle.
But it starts with the courage. All you need to do for that is buy the market and hold on for life. Everyone can do that.