How to Identify a Recession: Learn the Opportunities for Your Money

Money. Got a lot to cover today. We're going to talk about our outlook for 2023. The landscape for U.S. equities looked a lot brighter when we were coming into the new year, and for most of January it was a rally. Of course, everyone's asking what drove that move higher. Maybe investors have overlooked fundamentals; happens all the time. Expectations that an economic recession will occur have been rising, and some models are predicting the likelihood is now at 100 percent. Markets don't find their bottom before the recession.

So for years the Federal Reserve, most of you know this, they kept interest rates at very low rates, in fact near zero. Why did they do this? Well, low rates is another way of saying we need growth. More growth comes from more spending. After all, seventy percent of our GDP is created through consumer spending. It also means we didn't have inflation. The game plan was low rates equal more spending, which should create some inflation.

Then something that no one could predict: a global pandemic that quickly cooled the economy. Unprecedented amounts of money flooded the economy. We call that quantitative easing and monetary policy, so an engineering, if you will, of what would hopefully keep us out of a major recession. Then the printing of money and purchasing our own assets drove down interest rates, made consumer borrowing much easier because money was cheap. It reduced the value of our currency, and voila, we finally found the inflation that everyone thought would never return.

Then we heard the same old platitudes: it won't last, inflation will be transitory. And just like the garbage that was fed to us by Ben Bernanke, the old Federal Reserve chairman, and President Obama shortly after the Great Recession. Remember, they told us we would have something called escape velocity. Well, that really worked out not so good. Looks like we need some of that escape velocity now, and I don't believe we're going to get it, at least not yet.

So in March of last year, that's 2022, the Fed started raising interest rates as inflation was headed towards 40-year highs. Unbelievable inflation, and it peaked, at least we think it did, around 9.1 percent. The Fed panicked, pretty typical, and up went rates to the tune of 75 basis points four times in a row. Now, I doubt anyone watching this video has experience rates going from zero to four percent in less than one year.

Now, this spilled into mortgage rates. Everybody knows mortgage rates started going up, and it brought mortgage applications to a clean stop. So literally the banking world, they were enjoying mortgage rates being super low and mortgage applications coming in almost faster than they could process them over, so that stopped.

A lot of damage has been done, without a doubt. Incredible amounts of money being printed. It probably seemed like the right thing to do when economies were grinding to a halt, but the likelihood of any country printing their way out of an economic crunch, we think that's absurd. Here we are looking into the eyes of 2023.

One of our subscribers recently asked, what do you think about this January rally? Is it a head fake? Is this thing durable? Where are we headed next? Well, first, thanks for that great question. We appreciate you watching and we appreciate your support.

So on the surface, it's easy to believe in the latest rally, but just a little bit of digging just might change your perspective. Why? Towards the end of last year, markets began this strong move to the upside, but the question really should be, what caused the rally, and is it durable? Well, in our opinion, the surge has been largely supported by FOMO, so fear of missing out, and this greater appetite for cyclical investments over defensive Woods. Recoveries don't happen overnight. You have time. Don't follow the crowd thinking you're going to miss.

Now, when all of this was occurring, the Fed was very predictable. They slowed the pace on rate hikes back around December, hence the rally that started in late December. Given so many headwinds, it is hard to imagine this being anything more than a dead cat bounce. Now, we haven't seen that at this point, but that's what we believe. It is not sustainable for a lot of reasons.

The one that you can easily understand, however, is the Fed cutting off the printing presses. Non-stop rescue packages courtesy of the Fed, it spoiled us as investors. Really, since the Great Recession, we've seen the Fed step in and literally rescue the markets every time things started to get a little dicey. If the Fed is not pouring newly printed money into the system, our opinion is a sideways market at best is what we're going to get for much of 2023.

Let's dig a little deeper. It's likely that Federal Reserve Chair Jerome Powell will raise rates at least two more times, so at the next FOMC meetings we expect at least a quarter point. It's easy to know what the Fed's going to do if you just listen. They tell us. Jerome Powell has told us they are going to bring inflation down to two percent, and he said it will be painful.

While higher interest rates, slower growth and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. Even if they stop after the next two hikes, it's unlikely that rates will come down in 2023.

there is going to be, in our opinion, a long pause before these high interest rates begin to abate. They won't fall for the sake of falling. It will either take something that's broken or it's going to take time for everything to work through the system. The fact is, getting inflation to their target rate of two percent is not going to be easy, and it will not come without some pain.

Jerome Powell, and I quote, said there will be pain. In fact, in one of his last FOMC meetings where he was testifying, he said pain five times. I don't know that I've ever heard of Federal Reserve chairman use the word pain in their address that many times.

Of course, if the Fed overshoots, and we imagine they will since they always do, a pivot would happen later this year. So in other words, if they really break something, then we might see a pivot this year. If this juncture we think that doesn't happen, and we believe there's two outcomes: there's either recession, and we think it will be a deep embedded recession, or stagflation.

So a recession is generally said to be in motion once we have two consecutive quarters of negative economic growth. Of course, in 2022 we learned that politicians, when they don't agree, they just change the definition. In other words, we had to consecutive quarters of declining growth, yet the White House declared this was not a recession. Declining growth, we saw it, we're seeing it again, and I think a recession is imminent.

Stagflation, on the other hand, this one is much more open to interpretation. In this environment of stagflation, prices remain elevated and so do interest rates. So you have high cost and high cost of capital simultaneously. That's a tough, tough environment. So eventually something will break. By the way, the last time we saw real stagflation, you got to go all the way back to the 70s. Most of our listeners, you weren't even born the last time we had stagflation.

So markets are expecting the Federal Reserve to pivot sooner rather than later. If you look back into December, just the hint, just the hint of rates not going higher, it led to the latest rally. But consider these points.

Inflation: it remains unacceptably high. The Fed intends to bring it down from its current place of about 6.5 percent to something around two percent.

Next, at the same time that we have this stubborn inflation, wage growth is sluggish. Now, don't get me wrong, yes, wages have been moving up by about four to five percent year on year, but when you add inflation, all of a sudden you have real wage growth that's closer to negative two percent. In other words, wages are going up four to five, inflation's at six and a half, you're in a negative position. So that's not what we consider good wage growth.

Unemployment: it's going to rise. It's at a record 3.4 percent. That's an incredibly low number, and it doesn't include, this is important, it doesn't include workers that are no longer in the workforce, and there's millions of them. If we were to add those workers to the calculation, you'd find that unemployment is much higher than 3.4 percent. In fact, we would say it's closer to eight or nine percent. That's actually recessionary kinda or style numbers at that level. So if that's true, then we're already in a recession.

Lots of layoffs will eventually show in the unemployment rate, but remember, the rate won't change until these people that are being laid off file for unemployment benefits. They're considered employed until they make their claim, until they file.

Interest rates: we believe they will continue rising, and we think they will stay high for the next 8 to 12 months.

And then the economy globally is slowing. We can see this, and if you don't believe that we can simply see it from all the metrics, then look at one piece of evidence, and that's the Baltic Dry Index. And you might be saying, what is the Baltic Dry Index? Well, let me put it this way: the Baltic has been one of the best predictors of an economic contraction, and it's one of the best predictors of expansion, and right now it presents a compelling story of contraction.

Finally, we have an inverted yield curve. That has been the most accurate single indicator of a recession in modern history.

So let's talk about bear markets for a minute. So first, understand that these bear markets, they are deceptive. We've witnessed this recently, where we see markets rising sharply, like last October in 2022 through December. We saw this occur. Prodigious move, gained everyone's attention, looked great, and we saw what I call stupid money come rushing in, and that drove prices higher temporarily. But it's during times like this that our faith is tested. We get conflicting information. It's unpredictable. Price movement is unpredictable, and it makes us second guess ourselves. This is where that FOMO kicks in. And just like last year, we expect this January rally to give way to the pressure of fundamentals, and I think the fundamentals will always win in the long run.

Here's what I want you to know: corporate earnings are trending down, and we believe the likelihood of recession is reaching 100 percent. Now, no one can say how far markets will correct, or if they will. We don't know that for a fact, but we believe that markets have not seen their bottom. We can say that a lot of factors should not be ignored: inflation, rising interest rates, inverted yield curve, layoffs, sluggish wage growth, negative wage growth actually, when you tie inflation to that. And as we covered last week, don't forget we have a debt ceiling crisis that's adding fuel to the fire. A so-called soft landing, that's fading. The idea that that's going to happen, we think is quickly moving out of the picture.

Now, I know that everything I'm talking about is painting somewhat of a bleak outlook, but hang on, there is always a silver lining. There's always a bull market somewhere. I think some guy on television always says that. We've got myriad headwinds that are making a difficult economic environment even more difficult, but that's precisely the conditions that can lead to opportunity.

Most investors forget the fundamentals. When they see prices rising over multiple trading periods, they jump in with the crowd. Take that emotion out of the game. Invest based on what you're trying to accomplish. Stop following the crowd. So yes, you hear me right. I am saying that we believe stock prices do not include many of the challenges mentioned in today's show. That means we expect the January rally to lose strength as fundamentals take over.

We can't predict the future, but we can remind you of a few things that might help you sleep better at night and find better performance even in the midst of a recession. What are they?

The first thing is diversification. Most people think because they have 10 or 15 or 20 stocks in their portfolio that they're diversified. Please hear me, this is the most important part of what I'm going to say. The next things are important, but this one can be critical. Having 30 or 40 stocks may seem like you're diversified, but that's still one asset class. When we go through recession or other major events that affect our economy, stocks get really closely correlated. So if they're all correlated, it doesn't matter that you have multiple sectors; they're going to move in the same direction.

Diversification is much greater, it's much more important than just simply having a few stocks, and it's much more complicated than that. You need to have not just multiple stocks, but think about foreign, think about emerging markets, think about commodities, gold, silver, think about cash, real estate, hard assets. Lots of things need to be considered when you talk about diversification. Don't think that just because you have a few stocks you're diversified. Make sure you understand what diversification really means.

Next, avoid fear-based decisions. Emotional decision making can cause us to fall into these irrational decisions that hurt us in the long run. We believe that volatility is a short-term situation, yet your financial plan is built for the long term. So as markets rebound, making major adjustments to your plan, that can result in you missing out on the next rise in markets. We need to rely on our process to make good decisions. If you don't have a plan, I would suggest you get one.

Next, stay the course. It can be difficult to see your account values dropping significantly, and we understand that, we're human. So in these turbulent markets, and I suspect it's going to get more turbulent as we go through 2023, a plan is essential. It's an important piece to your financial success. It's also important to remember that while turbulence can be unnerving and make a flight uncomfortable, it doesn't usually prevent travelers from reaching their destination. So keep your eyes on the end goal. What's important to most of our clients isn't making the most money; it is achieving the goals that are most important. Things may get bumpy along the way, but remember, stay focused on your destination.

And then trust your plan. Your financial plan, it should be built on diversification, we talked about it a few minutes ago, and longevity, both of which help protect you from volatility. And I do believe you should be prepared for a lot of volatility in 2023. We can't emphasize this one enough: be sure to stress test your plan. Be sure that volatility is built in. Expect it.

Be mindful of your spending. When cost for goods and services are high, it's easy to overspend. People are doing it now. Credit card debt is at record highs. Be careful. Also, if you spend too much, you might find yourself being forced to sell investments in a down market. That means you're going to sell lots more of your investments to pay off your bills.

And don't lose your patience. True opportunities begin presenting themselves when you least expect it, and we believe they'll begin to present pretty soon. Don't buy into any mirages or false signals you may encounter. They're out there. Be careful. Focus on the fundamentals. Hold your nerve. Get your buying list ready. Patience will be rewarded.

We hope you've enjoyed today's show. There's so much when it comes to getting your financial life right. If you need help, share in the comments below that you're looking for a way to get a better handle on your finances. We're glad to help. Look us up online, check out our website, omnistarfinancial.com. If you need a second opinion, you'll find it on our website. You can simply let us know, and we're happy to deliver that and maybe help you make some better decisions. We'll see you next time when we're talking money.

Thanks for joining us on We're Talking Money. Be sure to visit us at omnistarfinancial.com, where you can learn more about how we provide value to our clients. So subscribe to the show and our newsletters, and drop us a line with topic suggestions for upcoming shows. If you enjoyed the show, we would appreciate you passing it on to a friend and providing a rating on iTunes.

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