Keep Calm and Carry On
A year of negative surprises, 2018 has turned out to be a year of losses for many investors. Unless one made money along the way doing short-term trades, options, etc. It was a year that held much promise for those who held the belief that a regulatory yolk was lifted from their shoulders with the November 2016 Election. And the metaphorical sugar high provided the economy by the tax cuts helped to boost investor euphoria.
The last recession was officially regarded as beginning January of 2008. In the six years leading up to that point, the average annual increase in the value of the S&P 500 on a price basis was less than five percent. The cumulative decline during the recession which ended June 2009 according to the National Bureau of Economic Research, was a little over 24%.
By contrast the financial market as defined by the S&P 500, has gained close to 10% annually in the years following the last recession up to the end of 2018 which included a downturn of over six percent. In the two years leading up to the 2008 recession, one measure of the delinquency rate on single-family residential mortgages increased by almost 90%.
The market rose less than 15% in the two years leading up to December 2018. What would be the trigger for a recession this time around?
The delinquency rate on mortgages
Not in the short term at least, as this metric has fallen 21% in the last two years
- Last February the observation was made that the US had a surplus of 2.9% with Canada, small deficits ranging from approximately zero percent (Mexico) to less than two percent for Germany. China had the biggest impact on US trade deficit with a net negative 10% of trade between the two countries
- The trade war initiated by the current US Administration has seen the favorable numbers observed before turn to the negative. According to the Bureau of Economic Analysis, the 2018 third-quarter deficit with the European Union was $30.2 billion, Canada $2.7 billion, Mexico $21.6 billion, Germany $16.3 billion and Japan $13.4 billion. In other words the US trade balance hemorrhaged with countries where America had previously enjoyed favorable balances. Data for the last quarter of 2018 is not currently available, but it most likely is not an improvement over the third quarter.
- The deficit with China increased $10.3 billion to $95.9 billion in the third quarter
- A loss of trading partners who may never return having lost faith in America as a reliable market or supplier; particularly so, as they establish alternate relationships which may prove to be long lasting
Think unemployment and shrinking consumer spending at a time when tariff-related increases in goods and services take hold. Think mortgage delinquencies. And the many unintended consequences that will drive up the cost of healthcare for instance, even as those services are curtailed. Think the domino effect of these phenomena.
But that’s one side of the coin. Much if not all of the above, could be reversed by 2020 on the assumption that adults prevail in Washington and much of what has been implemented in the recent past will be rescinded.
The domestic economy has a lot going for it. Low unemployment and borrowing costs, for instance. Another encouraging metric: Free cash flow as a percent of operating earnings has averaged almost 40% per quarter for publicly traded companies over the last ten years. This means there is a sizeable portion of cash left over even after spending on capital improvements, for returning to investors in the form of dividends and stock buyback.
The political and social equilibrium may be off center at the moment, but like a gyroscope will eventually revert to the norm. This should be the natural outcome as sane, calm leaders with fortitude prevail. Look for opportunities now before the last point becomes more apparent.