Economic Hurricane Requires Action - Strategies You NEED to Know!

With so many economic challenges, it's hard to imagine stocks continuing to rise. Now, the S&P 500 hit a so-called bottom back in October of 2022, and a lot of the experts believe this was the worst of what the market's going to give. I don't call bottoms or tops, for that matter, but I do call things like I see them. First, there is no evidence that we're starting a new bull market, though some believe that we are. In fact, my assessment for 2023 is a market that moves mostly sideways and probably down.

Now, we're going to discuss the market in terms of fundamentals, which is something you definitely want to understand. Then we are going to do something that we haven't done in other shows, and that is we're going to overlay with technical analysis just to provide some confirmation of the market's direction. Finally, what you can do to better protect your portfolio. Stay tuned.

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Welcome to another edition of We're Talking Money. I'm Phil Clark, founder and CEO of OmniStar Financial Group, and we're going to be talking about the economy and the markets today. First, let me be clear: I do not believe that we are in a new bull market, but that does not mean, not for a minute, that markets will cooperate. Just because I say so doesn't mean they're going to move lower. In fact, I think it's plausible that stocks will ignore the fundamentals at this point and maybe even react to the upside in hopes a Fed intervention. That is only my opinion, but the market is disconnected from reality. In fact, I think leadership is disconnected from reality.

Now, despite all of this, a sustainable market, if it is to go higher, if it is to become a new bull, it's going to require earnings to start moving higher, and the Federal Reserve is going to have to stop breaking things with higher interest rates. Oh, and one more thing: wouldn't hurt if we could get our gross domestic product, GDP, to find a little bit of momentum.

Now, it's important to know that consensus estimates are calling for about an eight percent contraction for first quarter earnings, followed, get this, followed by a six percent contraction in the second quarter. So that's two consecutive quarters of downward earnings consensus, and of course that can't spell anything good for the markets. For calendar year 2023, consensus estimates are still coming down, and if you look at historical patterns, I believe we could see earnings contract as much as eight, maybe ten percent.

What about the Fed? Everyone's talking about the Federal Reserve. What is that looking like, and how is that going to affect the market? Well, in our recent show, we called it Preparing for the Fed Pivot and Severe Recession, I talked about how close we are to the Fed starting to reverse the rate hike and likely start moving interest rates lower. Rather than taking my word, let's see what the market is saying about the Fed policy. Of course, this is based on forward interest rate curves, which should give us a pretty good picture of what the market is thinking. So from this perspective, investors are expecting not just a pivot but an aggressive pivot. Based on the data, it looks like the market is pricing for a pivot before the end of summer.

Now, herein lies the problem, in my opinion. The market is viewing this as a positive development, meaning lower rates. Low rates in recent years, they did in fact translate to a prodigious bull market, but it's not based on fundamentals, and fundamentals at the end of the day are what drive the market. Instead, I believe it's based on what we have come to expect, what investors have come to expect, and that is Fed intervention. For more than a decade, going all the way back to 2010, our Federal Reserve has refused to let things happen as they should. Even so, Fed intervention may not be the panacea that everyone is expecting this go-around.

So where do we go from here? Well, earnings season is upon us amid the Fed's cycle of interest rate hikes, and there's a real chance that earnings may not fall the way that we're thinking they will. In fact, they might only fall by a small amount. If that happens and the Fed is finished with rate hikes, which chances are, if earnings don't fall as much, the Fed has more reason to stop hiking rates. If the Fed is finished with the rate hikes, it's conceivable that stocks could follow through on their recent rally. Now, I've seen markets in my 31 years, I've seen markets surprise to the upside without warning, but my expectation is the opposite, at least this time around.

I believe a good sign is looking at institutional investors and what kind of exposure are they taking on in their portfolios, and likely you'd see them taking on higher beta stocks, more speculative companies, that is, small and mid caps. Instead, what we see right now is investors are favoring more established and less risky stocks.

So can stocks move higher from here? Well, absolutely, and so far they have maintained their intermediate uptrend. In fact, the S&P 500 remains comfortably above its key moving averages, and we're talking about the 20-day, 50-day and the 200-day moving average. This advance has been impressive, but in my opinion, a different story is being told by the S&P 500 Equally Weighted Index.

Now, a lot of folks might be asking, what is that? Well, you have the S&P 500 large cap, and then you have the S&P 500 equally weighted, and so this version of the S&P 500 gives less weight to larger stocks and offers instead a more realistic view of what the broader market is doing, and that's because the 500 stocks are equally weighted. That, my friends, suggests that the latest upturn in the S&P 500 may not be reliable or sustainable. You'll see by the chart on your screen that the S&P 500 large cap has continued moving higher, but the equally weighted index is doing just the opposite. It has really diverged in recent months, and you can see that very clearly on this chart.

So how do you navigate the recession? First, I just want to say that for political reasons that are beyond my comprehension, 2022 was a year of extreme volatility. Leaders could not even agree on what is or is not a recession. The classical rule has been that a recession is any two quarters of sequential GDP contracting. Be that as it may, the official call is determined by the National Bureau of Economic Research, and they don't really follow a fixed formula.

What we know is recessions are times when economic activity contracts, corporate profits decline, unemployment goes up, and credits for businesses and consumers becomes more difficult and more costly. Regardless of what the rules are about what is a recession or what is not a recession, we can at least understand those basics. Since 1950, the U.S. has experienced 11 recessions, and every one of them has sent stock prices much lower. Regardless of the definition, recessions cannot be avoided. They've been and they will be, but there are a few things you can do to reduce the impact on your finances.

First, resist anxiety and fear. People fear recessions because of layoffs and volatile markets that accompany them, but fear is neither a good basis for making investment decisions nor reason to be unprepared when a recession arrives. In other words, if you prepare, you're probably going to weather the storm pretty well.

Now, I live on the coast of North Carolina, and recessions are a lot like hurricanes. We get those from time to time here on the coast. These storms indeed pack a mighty punch, but they take weeks, sometimes months, to reach our shore. That gives us plenty of time to prepare. The approaching recession can also be seen well in advance, and that should give you time to prepare, but you must take action.

Here are a few points that I want you to consider. One, most recessions, they last less than a year. In fact, only three of the 11 recessions since 1950 went on for more than a year. Point number two, most recessions have a period of significant stock market drops shortly after the recession begins. Typically the markets go down a little bit in the year prior to the recession, and then the market dropped shortly after the recession begins. And keep in mind, we've yet to hear the official call of a recession in the U.S. That seems to suggest that we could have more downside on the market.

This is point three: for every recession, the stock market begins to recover by the recession end about half the time. So five of 11 of these recessions, the market is back above break-even by the end of the recession. Now, that's pretty amazing, really.

And then our most recent two recessions have been outliers in some fashion. The 2008 recession was by far the deepest. It was the worst stock market performance that we've seen in a recession. The S&P 500 went down some 54 percent. It also was the longest recession. It lasted 546 days. The 2020 recession, in contrast, had the steepest immediate sell-off. We're talking about the COVID recession now, steepest immediate sell-off, but was also the shortest recession on record, at only 60 days.

The good news is recessions only last nine months on average. Still, they can cause major damage to your portfolio, especially when certain types of assets have large allocations, large exposure. In every recession, it's worth mentioning that since 1950, in every recession, bonds have delivered higher returns than stocks in cash. Now, that's partly because the Federal Reserve and other central bankers have often cut interest rates in hopes of what? Stimulating the economy. And when they do that, this activity, these rate cuts, typically cause bond yields to fall and bond prices rise. If you're nearing retirement, this might be a suitable time to shift some of your funds from stocks to bonds. Since the Fed has been raising interest rates to slow growth, that means that right now bond prices are lower and yields are higher.

Next, what about cash? Everyone's talking about this, and everyone wants to know how do we handle cash. Well, we view this like any other asset class. Now, large allocations to cash, let me just say, that is rarely a good long-term strategy for most investors, and that's generally because cash doesn't pay very much in the way of interest. But cash held today in certificates of deposit or money market funds, that can provide a great cushion against market downturns during recessions. In the late phase of the economic cycle, which precedes the downturn, and I think we're at that point in this cycle, interest rates typically reach their highest levels. So if you're thinking about cash, now would be the time to consider making some of those moves.

So what about stocks, and how should you think about investing in them during difficult phases of the cycle? Again, I think we're in that phase. Without question, stocks have usually struggled during recessions. Stocks of companies in industries such as technology and media, they tend to postpone spending. They don't invest money during recessions, in periods of higher interest rates. Tend to really work against those types of companies. Financial stocks have also found it difficult under the latest conditions. This time around, financials were hit especially hard, and that's not only because of rising interest rates but also because banks, maybe they haven't been managing themselves the right way. That's another show.

But all stocks do not perform the same during recessions. Stocks of companies that make and sell goods and services such as food or health care, electricity, things that people need to purchase regardless of their state of personal finances or regardless of the phase of the business cycle, those types of stocks have performed relatively well. What I'm saying is, don't throw the baby out with the bath water. You might need to underweight some sectors, overweight some sectors, but there are ways to insulate your portfolio such that it performs better even though we're going through some difficult phases in the market.

And what about foreign stocks? You don't hear many people talking about that, but I think it's worth pointing out that, at least technically, the U.S. has not entered a recession yet. Other parts of the world, such as the European Union, they've likely already been in recession and chances are will recover before the U.S. Now, this means that international stocks, it could be offering maybe some deeper discounts as it relates to price to earnings. In fact, I'm quite confident that you can buy stocks at a deeper discount of the foreign type, that is, versus domestic stocks.

Reducing risk by diversifying your portfolio with bonds in cash, that could be a smart move. The late or pre-recession phase of the business cycle is historically a time of abrupt and unforeseen market moves. You don't want to get caught there. Because of this, you want to try to avoid overloading an asset class that maybe has historically delivered the highest returns during recessions. Why would I say that? Well, when the recession gives way to renewed economic growth, those asset classes will quickly turn into a significant drag on your portfolio.

And finally, to help manage the anxiety and fear from watching this market and this economy, where most of the time when you turn on the television there's nothing but bad news, it might be helpful to have a solid investment strategy as part of a broader financial plan, one that aligns with your goals, your time horizon and your ability to manage risk. For investors who are a decade or more from retirement, these recession-related periods of volatility, they might actually represent a chance for you to buy more high-quality stocks at discounted prices, or even other asset classes. On the other hand, a recession may have more implications for the portfolios of those who are already in retirement.

If you need help better understanding that, please reach out to one of our associates. Send us a comment, send us a question. We're happy to help. We'll definitely serve as a resource to give you a little more peace of mind as it relates to your investment program.

But let's recap. Number one, in the year prior to each recession, the market drops only about four percent

but it typically follows with much more downside. Number two, the recession itself sees steep market sell-offs, shedding 20 or more in usually less than six months. Now, the sell-off in 2022 on the S&P 500 was approximately 20 percent. Is there more to go? That remains to be seen, but as far as I'm concerned, I don't believe we found the bottom, at least not yet.

And number three, recovery from the market bottom tends to be swift and severe. The average recovery, please hear this, the average recovery is almost 40 percent in the first 18 months following the market bottom that is a part of a recession.

So what all of this means is that you literally need a crystal ball to time the market. But since that's not available, staying invested and managing risk, along with a well-devised financial plan, is likely the next best thing.

Now, I hope this edition of We're Talking Money has inspired you to have a look at your planning and your portfolio allocation. If you're not sure if you need help, talk to one of our associates for a second opinion. If you enjoyed the content of today's show, please like, share and consider subscribing to our channel. We so appreciate it. And don't forget, ring that bell so you never miss a great episode. I'll see you next time when we're talking money.

Thanks for joining us on We're Talking Money. If you'd like to learn more, check us out at omnistarfinancial.com. Subscribe to the show on YouTube, follow us on Instagram and Facebook. Tell us in the comments section what topics you'd like to hear in upcoming videos. If you enjoyed the show, give it a thumbs up and share it with friends.

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