Are We Heading into a Recession?
Most people believe that a recession is defined as two consecutive quarters of negative GDP. That is actually not how the National Bureau of Economic Research (NBER), the party responsible for determining when we enter and exit a recession, defines it. The NBER defines a recession as: "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales". What is also interesting about recessions is that the moment the economy is declared to be in a recession, we are typically closer to the end. The start date is realized in hindsight. Therefore, we do not think it is wise to base investment decisions on whether or not we are in a recession.
The important thing, and our central belief, is that we should invest based on where we are in the business cycle now. Not where we think we will be or where we were, but where we are today. We are never going to attempt to pinpoint the start or end of a recession. Rather, our aim is to identify when growth is accelerating or slowing. Since the global economy began to slow in the third and fourth quarters, broad markets have been on quite the ride. Volatility has picked up meaningfully and economic data has continued to deteriorate. This deterioration caused stock markets to fall meaningfully in the fourth quarter of 2018, causing a move to a more accommodative stance by the Federal Reserve and global central banks. Markets responded positively to the change in tune by central banks (in particular the Federal Reserve) and have rallied through the first two quarters of 2019, with the S&P 500 hitting all-time highs.
Nothing has changed from a growth perspective. Growth and inflation are still slowing and that means a portfolio should be concentrated in high quality assets regardless of the asset class. As valuations remain in the top decile of historical observations, we believe risk management should be a top priority and alternative investments (risk mitigating and lower volatility strategies) should probably play a greater role in a portfolio. Market psychology is positive still, so growth slowing does not mean equity markets have to fall. However, market psychology can turn on a dime, so managing risk is paramount at this stage of the cycle.
It is our opinion that we are entering a difficult quarter that will bring to bear more slowing data. Particularly, we anticipate earnings growth to decline substantially in the near term. The Fed will most likely move to cut rates by the end of July in response to slowing growth and inflation. Without any known catalysts that could reignite growth, we are not so sure it will be the only cut or accommodative action by the Federal Reserve. Currently our framework is signaling red for Valuations and Economic Growth, yellow for Federal Reserve Activity, and green for Market Sentiment. Will we enter a recession? We have no idea. However, growth is slowing now, we plan to stay in high quality assets, manage risk, and enjoy the ride.
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