Markets

How We Might Avoid A Recession: Asset Allocation Daily

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By SA For FAs :

A Historical View Of Wednesday's Rally

"After these one-day super rallies, the market was essentially flat one month later. Three months later the market was down about 2%. But here's the big takeaway: one year later, the market was up by 20% on average. This is understandable since these big up moves mostly happened during huge bear markets." ( StockMarketWhisperer )

Trading In Trying Times

"When market conditions get wild, it becomes more important than ever to stay psychologically level-headed; don't let your emotions drive you to make bad trades. Our trading process leads us to close open trading positions when near-term conditions become unhealthy. And that is exactly what several of our trading models just did." ( Jeff Miller )

Triumphing In Trying Times

"'Tis surprising to see how rapidly a panic will sometimes run through a country...Yet panics, in some cases, have their uses; they produce as much good as hurt. Their duration is always short...But their peculiar advantage is, that they...bring things and men to light, which might otherwise have lain forever undiscovered." (Thomas Paine in " The Crisis ," 1776)

Small-Caps

"Since the Russell 2000 ( IWM ) made its all-time high on August 31st, the small cap stock gauge is off 27.2%. That is the largest and sharpest correction for this index since the financial crisis...The Russell 2000 has had drawdowns this severe during the 1987 selloff, during 1990, 1998, 2002, and the 2008-2009 financial crisis...In each of the five episodes with similarly rapid and severe drawdowns, stocks have been meaningfully higher one year later and delivered meaningfully strong returns over forward periods." ( Ploutos )

Target-Date Funds

"Dear SEC and DOL, At $2 trillion and growing, target date funds (TDFs) are now ten times larger than they were in 2009 when you held joint hearings on their 2008 losses. TDFs have become riskier since 2008: bond holdings are longer duration (more volatile) and allocations to equities have increased. Is that the reaction you expected?" ( Ronald Surz )

IfA Recession Is Coming

"If a recession is coming, the odds favor a longer and deeper bear market (-42% over 17 months on average). But there's much variation within those odds... In the 1990-91 recession, stocks declined only 20% over a 3-month period, and during the 1929-33 depression, stocks declined 86% during a 33-month period." ( Charlie Bilello )

Thought For The Day

According to Charlie Bilello's always excellent data, the fact we've hit bear-market territory this week does not necessarily imply that we will have a recession. His article (linked above) does a nice job of presenting the data, which range widely. We just don't know how big a bear, if there will be a recession and if so, when it will come. Indeed, the chance of a recession accompanying the bear market, based on historical probability since 1929, is just 55%.

That, of course, is a tad above even odds. And yet, I think a recession will likely coincide with such bear market as does develop. The reason is that, despite the recent high rates of U.S. GDP and employment growth, there are simply too many underlying sources of risk for the economy, one or more of which can easily trip it up.

First, interest rates have been rising rapidly. We don't know, until the economy slips, how well it can tolerate those rate hikes, but my guess is not well, and for a simple reason: Debt at every level is extremely high. Having low rates for so long provided a perverse incentive to take out nearly free loans. Today, interest on corporate debt, consumer debt, and need I add, government debt will all need to be paid at much higher rates than originally assumed. Add just a little more stress - loss of a customer, loss of a job, weaker tax collection - and the less resourceful corporations, people, and governments will go bankrupt.

Secondly, the U.S. is among the stronger economies today, but so much of the rest of the world is in considerably worse shape, yet facing the exact same stresses. So as the rest of the world normalizes interest rates, we may see some quick collapses that can affect the global economy like a chain of dominoes. In other words, the world has grown hooked on cheap money, and turning off that spigot may be enough to send the most vulnerable economies into recession. But if not, the addition of a further stress, like tariffs and trade wars (if not resolved soon enough), can tip the balance.

Third, the shock resulting from the popping of asset bubbles is sometimes enough to bring on recession, as we saw precisely 11 years ago. Assets such as stocks or real estate carry a wealth effect, and a sudden freefall in wealth naturally depresses economic activity. In that sense, it seems logical to suggest that the more stocks fall without the economy falling into recession, the better chance we'll have of adjusting to the new situation and thus avoiding an impoverishment-induced recession.

In sum, the economy faces a number of high-level risks, any one of which of, or combination thereof, can tip the economy. But as I noted with respect to stocks falling, our ability to effect a soft landing may be key to helping us avoid a recession. In that sense, it's actually a good thing that the Fed has been letting some of the air out of the bubble. The trick is calibrating how much we can do this without sending our economic balloon flying all over the place. Similarly, it would be desirable for governments, and consumers, to gradually let the air out of their own balloons.

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See also U.S. Stock Market: The Road Ahead For 2019 on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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