Market Update Q2: Are We in a Recession?
The first quarter was tough.
The second quarter was worse.
I don’t know what the third quarter will look like, but I know there are three questions on everyone's mind:
1. Are we in a recession? (If not now, is one coming?)
2. When will inflation (specifically gas prices) come down?
3. How long will this market last?
So, let me just start by saying that I can understand if you are feeling anxious and nervous with markets down as much as they are. Obviously, we prefer positive markets each year, quarter, and month but unfortunately, that is not how investing works. In order to achieve long term growth, you have to be along for the ride in good years (‘19,’20, and ‘21) and bad years (‘18 and ‘22).
Despite the downturn, we feel very confident that over the long term markets will perform positively and produce excellent returns to patient investors. Furthermore, we are very satisfied with how our strategies are holding up. As you likely know, we believe in a globally diversified strategy with multiple asset classes (stocks, bonds, gold, value, growth, etc).
What may surprise most investors is just how poorly an incorrectly assembled and tech overweight portfolio is performing this year versus a balanced approach. Below is a graph of various indexes and their performance year to date. In the graph, you’ll notice the worst performing index is the Nasdaq (composed primarily of U.S. technology companies) compared with emerging markets, international developed stocks, U.S. small cap value, and bonds.
*In this graph indexes are represented by ETFs. It is not possible to invest in an index directly.
Now to the questions at hand:
1. Are we in a recession?
A recession is defined as two consecutive quarters of negative GDP growth (Gross domestic product). GDP is basically the total economic output of a country. The first quarter of this year was negative, and we won’t know the second quarter data until July 28th. Most economists think that the Q2 data will show really poor growth but negative growth is not expected. This means that the majority of economists are not predicting that we are in a recession. My view is a bit more pessimistic. I think there is a 75% chance that Q2 GDP growth is negative and we will officially be in a recession. I base this on a variety of data points (such as the Atlanta Fed GDP Now Tracker which is currently at .03% which can easily go negative). In addition to empirical data, I use anecdotal evidence that I am able to gain from meeting and discussing personal finances with dozens of families each quarter. If we are in fact in a recession, the news could potentially cause the market to sell off another 10%. But to be honest we might need that shock to get over this downturn and for things to finally start to rebound in a lasting fashion.
Ultimately, whether I’m right or wrong does not matter. We are investing for the long term and it is foolish to make investment decisions based on speculation even if that speculation is based on empirical data and anecdotal information.
2. When will inflation (specifically gas prices) come down?
Energy is not included in most inflation metrics. The simple reason is that it takes energy to get every product to every shelf. As a result, energy is included in inflation data points by proxy. I believe we are finally getting through many of the pandemic induced supply chain problems. We can see this as retailers have reported massive inventories. Target and Walmart reported they ordered as many consumer goods as possible from manufacturers. The retailers over ordered products for shelves as they did not know when the goods would arrive. Surprisingly, manufacturers were able to catch up with some demand and delivered many products on time creating a massive surplus in inventories (see below). This along with other data points leads me to believe that we are on the back end of the supply chain induced inflation.
When it comes to the contribution to inflation that energy has caused (specifically sky high fuel prices) I’m far more pessimistic about the outlook. It's hard to discuss this topic without talking about policy/politics but the topic should be discussed and I’ll just do my best not to unnecessarily offend someone.
The war in Ukraine has no doubt affected the price of energy worldwide. The war is unfortunately something that we cannot control nor predict. We all hope it resolves quickly and in the most humane way possible, but we simply cannot know when that will be. In the meantime, there is a great deal of policy that could be changed or pursued domestically to help increase the oil and gas supply. At this time there have been very few practical solutions proposed by the Biden administration to help the oil and gas supply problem. In my view, the energy problem is massive and needs to be treated as the number one economic issue. We need something resembling a Marshall plan. All hands on deck let's get this problem solved. We have massive energy resources and some of the most responsible extraction processes in the world. As a country, we should be encouraging new drilling development, refining capabilities, and the expansion of ports to export our excess supply (once we have an excess supply). This will help our national security and our economy. The world can and should be supplied with American energy and not be beholden to dictators and oligarchs.
As an avid outdoorsman, I’m as big of a fan of green, sustainable, and renewable energy as anyone but we cannot bankrupt ourselves towards a greener future. We have a major problem today in that our economy can be broken by unaffordable energy prices. In the coming decades, I have no doubt that our country will lead the world in the development of technology in sustainable energy, EVs, and carbon capture, but the technology is not ready for the green switch, so in the meantime, I’d love to see American energy dominate while we make those investments.
I’m also a staunch believer in free market capitalism. Actions like proposed price controls, proposed windfall taxes, and a reduction in available oil and gas leases do not provide the confidence needed for energy companies to make investments in capacity that won’t ultimately bankrupt them with help from regulation once the Ukraine crisis ends. For example, ExxonMobil has come under scrutiny for making too much last year and in Q1 this year. For context, they made about $23B in 2021 ($5.4B in Q1) but they also lost $22B in 2020. Their 2021 profit margin was at about 22% gross which is lower than Google, Lowes, Pepsi, Microsoft, etc. and hardly counts as price gouging. Furthermore, $23B might sound like a huge number, but Apple makes that much each quarter!
This is not me trying to cast blame but to frame the energy problem as far more complicated than greedy oil companies and Vladimir Putin. We need a working relationship as a country with our energy companies, policies that support a healthy supply, and a practical long term approach to solve this problem. Until those things happen or the war in Ukraine magically ends, energy and by extension, inflation will remain high despite the Federal Reserve raising interest rates.
3. How Long Will This Market Last?
We’re in a bear market now (20% down on the S&P 500) and truth be told no one knows exactly how long this will last. But this is what I do know.
Bear markets on average
- happen once every 4.5 years.
- last 11.3 months.
- experience losses of 32.1%.
We are six months into this market and I certainly hope it does not last another 6 months. But if it does, we feel that we are properly positioned to mitigate losses as best as possible and take advantage of the recovery when it does come. I also find solace in the statistics of what bull markets bring and after every bear market, there is another bull.
Bull markets on average
- last 5x longer than bear markets.
- have a cumulative return of 153.7%.
- Every single bear market in history has ended with the beginning of the next bull market.
As we navigate this unique market environment, please know that we are always just a phone call away to discuss. Whether you are feeling nervous about your retirement or just wanting a quick update on our thoughts about the markets, please never hesitate to reach out!
Enjoy the summer!
This commentary on this website reflects the personal opinions, viewpoints, and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Written by: Brice Carter