Recently, the markets have experienced another round of volatility as the worries seem to be piling up. Tech stocks struggled on the news that Washington will be taking a hard look at regulating them. Concerns over a trade war continue to reverberate throughout the market. And the yield curve remains inverted, escalating fears of a more severe slowdown. Further, the Nasdaq moved into correction territory (i.e., a decline of more than 10 percent from the peak), although it has shown signs of a strong bounce (as of this writing).
Given these risks and market turbulence, is there a recession on the horizon? Let’s take a closer at whether this is a possibility—starting with the economy.
Economy is growing
Economic growth drives market returns. As long as the economy is growing, markets tend to do well. In fact, although there can be sharp corrections during expansions, they are usually short. We have seen this scenario with the pullbacks in 2011, 2015–2016, and 2018, where corrections were sharp but reversed quickly. Sustained bear markets (e.g., 2000 or 2008), on the other hand, occurred when the economy went into recession. As long as we don’t have a recession, markets should recover from recent weakness.
Hiring and confidence are solid
At some point, we will have a recession. But the signs indicate that it won’t be soon. We have never had a recession with hiring and consumer confidence as strong as they are right now, for example. Although we did see a pullback in both, we have since had a recovery—which is positive. With consumer spending making up more than two-thirds of the economy, it is hard to get a recession when both hiring and consumer confidence are solid.
Yield curve bears watching
Historically, when the yield curve has inverted, a recession has occurred in the following 8 to 18 months. That clock may have just started. In theory, then, we could have a recession early next year. Before that, though, hiring and confidence would have to decline (see the previous paragraph). The yield curve is something to watch but is not an immediate problem.
Confidence has weakened, but may bounce back
The weakness in business confidence and investment is concerning. But this worry is one based largely around the expanding trade war. Despite that, both sentiment and investment remain positive. Further, although we do see some weakening, there has not been a decline. Right now, that weakness would not be enough to take the economy down.
The economy is like an oil tanker: it moves and turns slowly. Markets are like speedboats, orbiting around the tanker. They move faster and can certainly rock more on the waves, but they follow the big boat. As long as the tanker is moving forward, so do markets.
Right now, the economy is still moving forward, which should continue to support markets. Much of the recent turbulence has come from the news, especially around trade, which has affected confidence. Lower confidence—and more uncertainty—is bad for markets and explains what we have seen recently.
Confidence can improve as quickly as it deteriorates, however, and we have seen that several times during the recovery. The most likely case is that confidence will improve again, as growth continues, albeit at a slower pace. Even if we do see more slowing and a pending recession, we will still have time to plan our next steps.
The real lesson
And that is what we should be doing: keeping an eye on the economy, the markets, and our portfolios. The real lesson of the recent volatility is that we need to be comfortable with the risks we are taking. If not, we should take steps to ensure that we are comfortable.
After all, at some point we will see a recession and a bear market and will have to ride them out. As such, we must be prepared for when they happen. It just doesn’t look like that will be in the immediate future.
Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.
All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.
Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, at Commonwealth Financial Network®.
© 2019 Commonwealth Financial Network®