The essence of portfolio management is the management of risks, not the management of returns. All good portfolio management begins and ends with the premise! – Benjamin Graham (1894-1976), author of “The Intelligent Investor.”
Question: Should we be worried about the economy heading into a recession?
Answer: My answer might be “yes” if stock market volatility alone indicated the likelihood of a recession. Luckily, the economy and the stock market aren’t always connected. Presumably, financial markets move on information signifying company valuations like earnings, growth and profitability. Reality tells us that individual investors who participate in the market are also influenced by emotions, and that matters a lot.
During 2015, the Dow Jones Industrial Average (DJIA) traveled round-trip over 31,000 points. We started 2015 at 17,832.99 and finished the year at 17,425.03, for a net drop of 2.23%. Whether this outrageous volatility continues is anyone’s guess, but my sense is that it will. In past columns we’ve discussed issues that cause worry and concern, some of which were real, while others were imagined and overdone. Preparing yourself and your portfolio for more of the same volatility based on emotion and consumer sentiment may be wise.
A recession is defined as “an extended period of decline as measured by Gross Domestic Production (GDP),” which is the annual market value of all goods and services produced domestically by the U.S. Other predictors include reductions in economic activity, personal income, business sales and industrial production with increased unemployment. All of these have remained positive in the latest reports, with the exception of industrial production, which lagged due to the decline in energy exploration. According to Leading Economic Indicators (LEI), the data does not indicate that we’re heading for a recession; slowed growth perhaps, but not a recession.
Top Twelve Leading Economic Indicators
Growth- GDP growth is likely to be more moderate than expected, reflecting a drag from foreign trade and slower inventory growth. Domestic demand should remain relatively strong.
Employment- Payroll growth in nonfarm jobs has remained constant, while job destruction is relatively limited at this time.
Consumer Spending- Lackluster job growth has been offset by low gasoline prices, resulting in steady consumer spending.
Business Investment- Caution remains with capital expenditures, but it isn’t clear if this is a short-term phenomenon based on politics or a longer-lasting trend.
Manufacturing- Increased auto-production and sales led the way, but across other industries the results are lower, reflecting softer global growth.
Housing and Construction- Progress is expected to be moderate, supported by job growth. Tight credit restricts many potential homebuyers.
Inflation- Expectations remain low due to lower commodity prices. A contra-indicator is rising rents and a small increase in the Personal Consumption Index, which rose 0.60% last year.
Monetary Policy- Following the December interest rate hike and resulting market action, policy will likely remain very accommodative to preserve limited growth.
Long-Term Interest Rates- As the economy improves, long-term rates should trend gradually higher. Low inflation keeps rates low. Bond yields have fallen with the global flight to safety. Buying bonds drives prices up, decreasing effective yields.
Fiscal Policy- Federal fiscal policy isn’t a big plus to growth of GDP, but it’s not the drag it has been. The federal debt ceiling allowed us to dodge a default on our debt and avert government shutdown.
The Dollar- As the U.S. dollar continues to rally (flight to safety—see #9) and strengthen against other currencies, especially China, our products are more expensive as exports, while imports become more attractive.
Rest of the World- Low oil prices and easy money should help the U.S. and the rest of the world eventually recover, but there are risks in the near term. Softer global growth is likely to put some downward pressure on corporate profits.
We could actually talk ourselves into a recession because of the psychological aspect to economics. In today’s vernacular, we refer to this as the “Law of Attraction,” meaning that our thoughts and beliefs manifest into reality. Fear alone of a recession can spark a downward spiral, with financial institutions being especially vulnerable. For instance, if someone mentions a possible run on the banks like in Greece, there will likely be a run on the banks. Or, if worried consumers save an extra 5% (effectively spending less), that reduced spending translates into a decrease in someone else’s income. This is true because businesses would reduce capital expenditures based on the lower demand for their goods or services. Until there is a hint of good news the cyclical downturn could continue.
Fortunately, consumers seem to be ready and willing to spend. The Leading Economic Indicators do not suggest that we are in, or are approaching, a recession. This is not to say that some fears could turn into self-fulfilling prophecies creating more of the same volatility that we saw last year. The expectation is that the U.S. economy will muddle through with slow growth. Stay focused and plan accordingly.
The opinions expressed are those of the writer, but not necessarily those of Raymond James & Associates, and are subject to change at any time. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ. Investors cannot invest directly in the DJIA.
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This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. Call or email Darcie at 239-389-1041 or firstname.lastname@example.org with questions or suggestions for future columns. Visit her website: www.raymondjames.com/Darcie