Tag Archives: Recession Risk

Inflation: The Elephant in the Room

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November’s CPI report showed consumer prices rising at rates last seen four decades ago.

Inflation is the biggest risk facing the equity market and is likely to end the record long bull-market. Inflation has a long history of eroding the value of financial assets and brings with it higher interest rates as central bankers try to tamp it down.

The annual inflation rate accelerated significantly in 2021, from about 0.5% at the start of the year to over 3% by September. This was driven by increased demand as the economy reopened and by a sharp rise in energy prices, among other factors.

In October, inflation measured by the consumer price index was up 6.2% from a year earlier, the highest annual rate since November 1990. It marked the sixth straight month above 5%. Kiplinger expects inflation to hit 6.6% by year-end 2021 before falling back to 2.8% by the end of 2022 – above the 2% average rate of the past decade.

“Inflation is in the air, and it risks becoming a market issue, an economic issue and a political issue,” says Katie Nixon, chief investment officer at Northern Trust Wealth Management.

As we enter 2022, inflation is expected to remain a risk amid higher food and gas prices, rising pressures from non-energy industrial sectors such as steel and chemicals, higher food and consumer goods prices, and increases in the energy prices.

Economists expect headline CPI to peak between 4.5% and 5% in the first half of 2022 and approach 2.5% year over year by the end of 2022.

References;

  1. https://www.kiplinger.com/investing/stocks/stocks-to-buy/603814/where-to-invest-in-2022
  2. https://investor.vanguard.com/investor-resources-education/article/simple-strategies-for-reducing-inflation-risk

The Debt Ceiling and Congressional Brinkmanship

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“I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.” Warren Buffett, Chairman and CEO, Berkshire Hathaway

Around October 18, Treasury Secretary Janet Yellen and the U.S. Treasury Department have warned Congress that the government will no longer be able to pay all its bills unless the $28.5 trillion statutory debt ceiling is increased or suspended.

Source: Congressional Research Service, Congressional Budget Office, and the Treasury Department. Data as of 05/01/2021.

Moreover, Secretary Yellen believes the economy would fall into a recession if Congress fails to address the borrowing limit before an unprecedented default on the U.S. debt.

While the U.S. has never failed to pay its bills, economists say a default would tarnished faith in Washington’s ability to honor its future obligations on time and potentially delay Social Security checks to some 50 million seniors and delay pay to members of the U.S. armed services.

“If you ask the question of Americans, should we pay our bills? One hundred percent would say yes. There’s a significant misunderstanding on the debt ceiling. People think it’s authorizing new spending. The debt ceiling doesn’t authorize new spending; it allows us to pay obligations already incurred.” Peter Welch (D-VT), U.S. House of Representatives Democratic Caucus Chief Deputy Whip

Increases to the debt ceiling aren’t new. They’ve occurred dozens of times over the last century, mostly matter-of-factly, a tacit acknowledgement that the bills in question are for spending that Congress has already approved.

One thing separating today’s debt debate from those of the past is the larger-than-ever national debt, according to Fidelity. Publicly held US debt topped 100% of GDP in 2020 and is expected to reach 102% by the end of 2021.

And the debt is projected to increase significantly in the future. The Congressional Budget Office (CBO) projects a federal budget deficit of $2.3 trillion in 2021—the second largest deficit since 1945.

Source: Congressional Budget Office, as of February 11, 2021.

Failure to address the current challenge could shake global markets even before the Treasury has exhausted its available measures to pay bills. A U.S. debt default, whether through delayed payments on interest owed on U.S. Treasuries or on other obligations, would be unprecedented.

The effect would be one of perception. And, perception can be tied to the reality that someone isn’t going to be paid on time, whether it be government contractors, individuals who receive entitlement payments, or someone else. The damage to U.S. credibility would be irreversible.

Even if a default were only technical—if payments other than interest on debt were delayed—the United States could no longer fully reap the benefits bestowed on the most reliable debtors.

Interest rates would likely rise, as would financing costs for businesses and individuals. Debt ratings would be at risk. The government’s own financing costs, borne by taxpayers, would increase. Stock markets would likely be pressured as higher rates made companies’ future cash flows less predictable. Such developments occurring while economic recovery from the COVID-19 pandemic remains incomplete makes the potential scenario all the more important to avoid.

Let it be said that no one doubts the ability of the United States to pay for its obligations, according to Vanguard. There is a minimal credit risk posed by the United States is supported by its strong economic fundamentals, excellent market access and financing flexibility, favorable long-term prospects, and the dollar’s status as a global reserve currency.

The House has passed a measure that would suspend the debt ceiling through mid-December of 2022, and the bill now goes to the Senate. Republicans in the Senate oppose any effort to raise the borrowing limit and appears intent on making Democrats address it as part of their sprawling investment in social programs and climate policy under reconciliation.

Senate Democrats could lift the debt ceiling without the GOP votes through reconciliation, although that would come with downsides. Under reconciliation, a simple majority of senators can pass a very small number of budget bills each year. The process is sufficiently complex that it would probably take a couple of weeks and distract Democrats from their negotiations over Biden’s “Build Back Bette” agenda.

Thus, the Democrats resist raising the debt ceiling through reconciliation if it means potentially sacrificing other policy goals. And, the rules for reconciliation would require Democrats to specify a new limit for the national debt which would expose them to potentially uncomfortable GOP political attack ads.

Republicans insist that since Democrats control both the executive and the legislative branches and are in a socialistic tax-and-spend binge, they should bear sole responsibility for dealing with the debt limit, which is rearing its ugly head again because the suspension included in a two-year 2019 budget deal expired on July 31.

Democrats argue that Republicans should share the burden of this unpopular chore, since (a) much of the debt involved was run up under Republican presidents and (b) Democrats accommodated Republicans on debt-limit relief during the Trump presidency.

For long term investors, it’s clearly in the best interest of the country to resolve any debt-ceiling issues, according to Fidelity. And, it’s important to understand that there will always be times of uncertainty. It’s important to take a long-term view of your investments and review them regularly to make sure they line up with your time frame for investing, risk tolerance, and financial situation.

References:

  1. https://investornews.vanguard/potential-u-s-debt-default-why-to-stay-the-course/
  2. https://www.cnbc.com/2021/10/05/debt-ceiling-us-faces-recession-if-congress-doesnt-act.html
  3. https://nymag.com/intelligencer/2021/10/democrats-can-raise-debt-ceiling-via-reconciliation-bill.html
  4. https://www.fidelity.com/learning-center/trading-investing/2021-debt-ceiling

Dr. David Katz | Real Time with Bill Maher (HBO)

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Dr. Katz believes the fight against coronavirus is worse than the disease

Preventive medicine and public health specialist Dr. David Katz joins Bill Maher to discuss whether the fight against coronavirus is worse than the disease.

Dr. Katz wrote a New York Times op-ed on March 20 titled “Is Our Fight Against Coronavirus Worse Than the Disease?”

In the op-ed, Katz argues against the self-isolation policies put in place by most of the U.S. He advises that instead locking down the country; we should isolate the elderly and most at risk, which would thus “allow most of society to return to life as usual and perhaps prevent vast segments of the economy from collapsing”.

Guidelines for States to Reopen their Economies

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Several states, including Ohio, Texas and Florida, have said they aim to reopen parts of their economies, perhaps by May 1 or even sooner.

Trump Administration’s guidelines to reopen the economy recommend a state record 14 days of declining case numbers before gradually lifting restrictions.

The guidelines call for a phased-in, science-based strategy in keeping with the advice of leading health experts. Moreover, the plan hinges on widespread testing to gauge the scope of infections and how many people might have developed immunity to the virus.

Health experts say that to avoid a second wave of infections as people return to work, extensive testing must be available to track infections, as well as contact tracing and antibody testing to learn who had been previously infected and might have some immunity.

The governors of Michigan and Ohio have said they could double or triple their testing capacity if the federal government helped them acquire more swabs and reagents, chemicals needed as part of the testing process.

Facing economic collapse

Stay-at-home orders and the closure of non-essential businesses have strangled U.S. commerce, triggering millions of layoffs and forecasts that America is headed for its deepest recession since the economic collapse of the 1930s. The result has been mounting pressure to ease the shutdowns.

Partisan bickering is escalating between President Trump, who had touted the strength of the U.S. economy, and governors in hard-hit states who warned against lifting restrictions too quickly.

At a White House briefing on Friday, Trump’s coronavirus task force members, through statements and graphics, pushed back against criticism from some governors and lawmakers that limited testing ability is impeding the country’s return to normalcy.

  1. https://www.reuters.com/article/us-health-coronavirus-usa/u-s-coronavirus-crisis-takes-a-sharp-political-turn-idUSKBN21Z2HN

Market Timing

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“The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has done it successfully and consistently.” Jack Bogle

During the 2008 financial crisis and economic uncertainty, global financial markets were melting down and Lehman Brothers filed for bankruptcy protection.  The resulting economic recession and global slowdown brought unemployment rates in the U.S. as high as 10 percent.  And, the U.S. stock market lost trillion of dollars in value as the S&P 500 experienced a single day drop of 90.17 points, nearly 9.04 percent.

Americans, and specifically American investors, believed inherently that the global economy and financial markets were collapsing.  Fear and panic selling took hold worldwide.  Both professional and retail investors started to sell and it didn’t matter what they sold.  Yet, Warren Buffett was buying stocks that were rapidly falling in price when everyone else was panic selling and sprinting to cash.

“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” Warren Buffett

According to Buffett, “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful,” he wrote in the NY Times.

Additionally, Buffett wrote in his 2018 shareholder letter.

“Seizing the opportunities when offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta.  What investors then need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period — or even to look foolish — is also essential.”

There are several valuable lessons investors learned from the 2008 financial crisis that can be applied towards today pandemic driven crisis.  The lessons are based on the same principles that allowed Buffett to invest so effectively during the crisis. To sum them up:

  • Don’t panic and sell stocks simply because the market is crashing. When times get tough, Buffett is invariably a net buyer of stocks. For this reason, he keeps billions of dollars in cash on the sidelines — so he can take advantage during times of investors’ fear and panic selling.
  • Focus on best-in-breed companies trading at discounts. A great example was Buffett’s investment in Bank of America and Goldman-Sachs.
  • Don’t try to time the market. Just because the market has crashed doesn’t mean it can’t go down more. It certainly can. Instead of trying to invest at the absolute market bottom, focus on stocks you want to hold for the long term.
  • Understand that no stock or industry is completely immune. Back then, many investors had a disproportionate amount of their portfolio in financial stocks because they were thought to be safe.  Essentially, no stock or industry are safe.

Warren Buffett believes intrinsically that “it is a waste of time and hazardous to investment success trying to time the market”.  In a 1994 annual letter to shareholders, Buffett wrote:

“I never have an opinion about the market because it wouldn’t be any good and it might interfere with the opinions we have that are good.  If we’re right about a business, if we think a business is attractive, it would be very foolish for us to not take action on that because we thought something about what the market was going to do. … If you’re right about the businesses, you’ll end up doing fine.”


Bottom line: As long as investors keep a level head and maintain a long-term perspective as Buffett does, investors should come out of it just fine, if not stronger than they went in.

Sources:

  1. https://www.cnbc.com/2018/09/14/warren-buffetts-rule-for-investing-during-the-financial-crisis.html
  2. https://www.fool.com/investing/2018/09/23/10-years-later-warren-buffett-and-the-financial-cr.aspx
  3.  https://www.cnbc.com/2018/05/08/warren-buffett-says-he-never-tries-to-time-stocks-i-never-have-an-opinion-about-the-market.html
  4. https://www.cnbc.com/2018/02/24/highlights-from-warren-buffetts-annual-letter.html

Uncertain Financial Markets

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“Don’t gamble. Take all your savings and buy some good stock and hold it till it goes up; then sell it. If it don’t go up, don’t buy it.” Will Rogers

Since the financial crisis of 2008-2009, the U.S. stock market has been on a long-term uptrend. In the crisis’ aftermath, a nearly 11-year bull rally emerged from its ruins becoming the longest-ever uptrend in Wall Street history.

And, the American economy is equally robust as consumer spending remains strong and as the unemployment rate (3.5%) remains at the lowest in 50 years. Despite low employment, Federal Fund interest rates still sit near historical lows and the 10-year Treasury yields only 1.8%.

Financial Crisis

Bringing back painful financial memories for investors, the financial crisis of 2008-2009 wreaked havoc on the stock market. During the crisis, the S&P 500 index (SPX) lost 38.5% of its value in 2008, making it the worst year since the nadir of the Great Recession in 1931.

Today, many economists and financial industry pundits conclude that global economies will face an increasingly uncertain and potentially volatile future. Those future concerns range a gambit of political, geopolitical, economic and socio-political issues.

The uncertainties and concerns include the upcoming U.S. presidential elections, potential turmoil in the Middle East, growing fear regarding cross border spread of the Novel Corona virus, and the growth concerns regarding the economies of the rest of the world economies.

Investing in an Uncertain Environment

“Never under estimate the man who over estimates himself…he may not be wrong all the time.” Charlie Munger

When it comes to investing in an uncertain environment, it is difficult to know what actions to take. But, nobody knows with certainty what is going to happen next in the markets or can predict the direction with certainty of the global economy. Despite the many self proclaimed stock picking experts who promote their ability to forecast the markets and abilities to select the next Amazon-like stock, it important to always remember that no one knows what will happen in or can accurately forecast the future.

Recently, Charlie Munger, Vice Chairman of Berkshire Hathaway, shared his thoughts about investing in general and regarding Elon Musk and Tesla, specifically. He commented that Elon is “peculiar and he may overestimate himself, but he may not be wrong all the time…”.

Additionally, Munger commented that he “…would never buy it [Tesla stock], and [he] would never sell it short.” Prudent investors would be wise to heed Munger’s advice and be concerned not only about potential rewards but, more importantly, also concerned about potential risks investing in hot, high flying stocks.

In Munger’s view, there exist too much “wretched excess” in the market and investors are taking on too much unnecessary risk. He worries that that there are dark clouds looming on the horizon. And, he believes markets and investors are ill-prepared to weather the coming market “trouble”.

References:

  1. https://www.marketwatch.com/story/wretched-excess-means-theres-lots-of-troubles-coming-warns-berkshire-hathaways-charlie-munger-2020-02-12

Jobs, Coronavirus, and the Budget | First Trust Economics Blog

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Brian S. Wesbury, Chief Economist

Date: 2/10/2020

In January, US payrolls expanded by 225,000, not only beating the consensus forecast, but also forecasts from every single economics group.  Since January 2019 (12 months ago), both payrolls and civilian employment – an alternative measure of jobs that includes small-business start-ups – are up 2.1 million.  The labor force – those who are either working or looking for work – is up 1.5 million, while the jobless rate fell to 3.6% from the 4.0%.

The labor force participation rate (the share of adults who are either working or looking for work) increased to 63.4% in January, the highest reading since early 2013.  Participation among “prime-age” adults (25 to 54) hit 83.1%, the highest since the Lehman Brothers bankruptcy in 2008.   

Meanwhile initial claims for unemployment insurance hit 202,000 in the last week of January, and initial claims as a percent of all jobs are at the lowest level ever.  In other words, the job market and the economy look strong.

Only a few months ago, some analysts were saying that the inversion of the yield curve – with short-term interest rates above long-term rates – was signaling the front edge of a US recession.  Now a recession seems nowhere in sight.

Lately, financial markets have become very jumpy on any news – good or bad – regarding the coronavirus.  We aren’t immunologists (or doctors) and would never make light of a virus that has killed more than 900 and infected over 40,000, but data released by the World Health Organization (WHO) cautiously suggests a positive turning point has been reached.

— Read on www.ftportfolios.com/retail/blogs/economics/index.aspx

Companies Cut Back, but Consumers Party On, Driving the Economy – The New York Times

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American consumers are energetically engaged in a spendathon. American businesses, by contrast, are not.

Businesses and households swim in the same economic soup and their outlooks — gloomy or bright — are usually in sync. But in recent months, the two seem to occupy opposite ends of a teeter-totter, with consumers continuing to spend while business owners and managers are chastened by doubt and uncertainty.

The economic expansion has extended its record run despite this curious divergence. The question is how long it can continue.

— Read on www.nytimes.com/2019/11/04/business/economy/economy-consumers-business.html

Strong U.S. Consumers

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Most economists or financial pundits concede that it is difficult to have a U.S. economic recession in the next twelve to eighteen months with the historically low (3.5%) unemployment rate and strong consumer spending. Essentially, the U.S. consumers, who represents 70% of the U.S. economy, are coming to the rescue the economy.

Eventually, those predicting and appear to be even rooting for a recession prior to the 2020 Presidential elections will be correct someday in the future. Bottom line, since the business economic cycle has not been repealed, recessions are inevitable and a normal part of the cycle.

Business hiring and historical low unemployment rate are lagging economic indicators for forecasting the strength of the economy. Today’s strong U.S. consumers due to hiring and low unemployment rate have buoyed the economy and can mask moderating and slowing economic growth.

China trade talk uncertainty and threat of additional U.S. tariffs on China and the European Union continue to weigh on the global economic growth and health.

No one…repeat no one, is able to forecast the future direction of the economy.

Dow Jones Industrial Average Battles Back as Recession Fears Recede – Barron’s

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The Dow dropped more than 3% on Tuesday and Wednesday on fears of a recession, making it the worst start to a quarter since 2008. A more optimistic view prevailed by the end of the week.
— Read on www.barrons.com/articles/dow-jones-industrial-average-battles-back-as-recession-fears-recede-51570238255