Preparation is key for all investors
Calling for a recession has recently become a “thing” for many Wall Street pundits. But after 10 years of unending U.S. economic growth, and currently
fading global growth, that declaration does not qualify any of us for the investment strategy Hall of Fame. However, if any of us who have been pleading with our audiences to pay attention to what is happening stop doing so now, that would clearly place us in the “Hall of Shame.”So, without fanfare, here is a straightforward look at what is going on, and why the coming recession itself is NOT the issue for you. It is how you prepare for it. Because if you do, you actually have a chance to profit from it.
Evidence is piling up that the U.S. is heading for a slowdown. And as I have written to you frequently, that in itself is not as important as what investors as a whole (“the market”) do with that information. We could technically avoid a textbook recession, defined as 2 consecutive quarters of negative economic growth), but if the markets react to the rumor and not the news, so to speak, the result to you is the same: generally lower stock prices and a potential shock to the bond market.I looked back at what I have written about the growing number of threats to wealth over the past couple of years, and in particular an article I wrote for Forbes.com back in January 2018 highlights some of what I then called “lingering threats to investor wealth.” This was just before I formally changed our Investment Climate Indicator to “Stormy,” where it has remained for over 14 months.It will come as no surprise to you, based on what you read above, that exactly none of these have been resolved yet. They are still lingering.
Here they are:
Margin debt Junk bond spreads Nasdaq vs. NYSE performance The Fed’s “predicament” Falling 10-2 Treasury yield spread A brief explanation of each, to bring you up to date:
Margin Debt – the U.S. stock market has had a strong 10-year run. So too has the trend in the amount of money lent to investors to buy stocks, otherwise known as margin debt. As with skyrocketing corporate, government, student loan and other debts, no one seems to care…until they do. And when the recession calls start coming in full force, this will put the economy in an awkward position, to say the least. More on that in item number 4 below. High-Yield (Junk) Bond Market Spreads – investing is all about evaluating the return potential versus the risk of significant loss. For any bond of a specific maturity (1 year, 2 years, 10 years, etc.), the U.S. Treasury is considered the safest investment for that maturity length. A “spread” for another type of bond is how much more yield you get for owning bonds that are less secure than U.S. Treasuries. In particular, I find that looking at the spreads of the first two levels of lower-quality “junk” bonds gives us a good idea of how much greed there is versus fear in the markets. Today, as in early 2018, greed is trumping fear by a wide margin, as BB and B spreads are at 2.3% and 4.3% respectively. Those are only slightly elevated from where they were at the start of last year. They are starting to creep up, but at a pace that tells me that there is no rush to the exits right now. It is also interesting that in the lower-than-low category of junk bonds (rated CCC and below), spreads have already ticked up noticeably more than those in the BB and B range. Stay tuned. Nasdaq Composite vs. NYSE Composite 
Related:
The Rising Risk of Stock OwnershipIn, the U.S., there are two main places a company can list their stock: the New York Stock Exchange (NYSE) or the Nasdaq. The above chart shows that securities listed on the latter exchange are routing those listed on the NYSE the past 5 years. It’s not even close. In fact, it’s a 4-to-1 margin. Another way to look at it is that non-Nasdaq (i.e. NYSE) securities have returned about 4.2% (plus dividends) annualized since April 2014. That’s OK, but it does show us that the “less sexy” part of the U.S. stock market has been moving at a pedestrian pace for a while. Meanwhile, the media, investors and speculators fawn attention all over the tech-heavy Nasdaq. While tech is where the growth has been and will be, you must ask yourself, at what price? This is one of many things that remind me of pre-recession, late-stage bubble stock market disparities of the past, especially that of the Dot-Com Bubble era (2000-2001).
The Fed’s Predicament – back in early 2018, I showed how much effort the Fed had put into keeping the U.S. economy from rolling over. This has continued, and as the long-term implications of low interest rates just keep getting more concerning. So, as with the rest of the items on this short list, be aware now so that you are prepared later…whenever later may be. A Falling “10-2 Treasury” Spread – I feel it is my duty in a blog of this nature to trot out this chart as often as needed, until the significant risk it forecasts is resolved. The risk I am talking about is recession. That’s what I wrote 15 months ago. Here is what it looks like now:
While the “official” warning sign of a negative spread has yet to occur, this indicator is hanging around at levels at which it rarely if ever reverses for the better. The media has jumped on this, and of course there are “this time is different” types. I encourage you to tune them out. The bond market knows a lot more than many investors give them credit for.
CONCLUSIONSThe key to investing amid this pre-recession situation: if you are currently cautious in your investment approach (as I certainly am), don’t get roped into the greed. These things take time, and there are plenty of ways to grow capital now while being defensive, as well as ways to pounce on a bear market in stocks and/or bonds, which are both on the table once the ultimate recession (or sustained fears of one) occur.
