Are we headed into a recession?

Are we headed into a recession? I get this question all the time, maybe 10 times a week. Unemployment numbers a few weeks ago was the highest since the beginning of the pandemic1, the virus is still spreading, and yet the markets are apparently brushing it off.

For those of you that follow the economy and the markets, you understand that gravity is a thing. What goes up must come down. Now, that said, markets don’t fall ‘just because they’re due’. There’s no timer or deadline that the markets follow but rather rules of economy. There are fundamentals that we use to determine the general health of the economy, just as we use to determine the health of specific sectors and even individual companies, stocks and bonds, etc.

One thing that’s constantly on our radars lately is the fact that some of these fundamental statistics are screaming at us and yet the markets seem to be brushing them off. So, I’m going to go over what some of these are and what you should be doing about it.

Unemployment

ADP, the big payroll firm, does economy research and a few weeks ago, new unemployment numbers shot up to nearly 1M that week, as reported by ADP on the weekly jobs report. That’s the highest since the beginning of the pandemic.

COVID-19

While we are seeing vaccinations being distributed, the rate is still low and there are many states that have run out and are still waiting for more. I’m in the DC area and I can tell you that’s what we’re seeing here too. The consensus is good that we’ll get there, but how much time will it take, and what’s going to happen in the meantime?

Markets are on Auto-Pilot

You might have noticed that the economy and the markets seem to be strangely uncorrelated as of late. The fact that bigger companies can keep rising at the same time that weekly jobless claims soar, is a strange phenomenon. This points to the fact that things are changing. The environment is changing and so we need to be looking at different things than what we’ve always historically looked at.

This dichotomy is what some people are calling the “K” Recovery. A “V” recovery is one where we have a sharp return shortly after a market crash, a “U” recovery is one that’s a bit more prolonged, and a “K” recovery is one where certain parts of the market keep rising (think Amazon, Google, Facebook, Microsoft) while the other parts of the market are still in recessionary territory.

Those 4 stocks are the largest 4 companies in terms of market capitalization, and they’re worth $6 Trillion dollars. Hang on to this stat until later.

And that’s what we’re seeing, we’re seeing parts of the market that keep rising and those big names are part of the indices that we hear about in the news like the DOW, the S&P500, etc…which by the way, would be investments that are similar to those in your C and S funds, these names keep rising in price and drive the index prices higher while the other parts of the index are trailing. The top 50 companies in the S&P500 are so far ahead of the remaining 450, and this massive difference is cause for concern.

At some point, the market will begin to price in the fact that these companies are insanely priced right now. Look at Tesla for example.

Now folks: we’re not in Lalaland. There are factors that are actually contributing to some of this growth. Economic stimulus that the government have provided is a big part of that, but you have to realize that the market has likely already priced in new stimulus.

Stimulus

So, stimulus is good right? It depends. Too much stimulus is bad. One example of this is the rate at which the government is buying back US debt obligations, or bonds. (This would be similar to your G Fund). Other countries have been selling US bonds and part of the stimulus is money to buy these treasuries back to keep the prices up. But doing too much of this is bad. The combination of large buybacks and low interest rates can accelerate inflation, which means your dollar won’t be worth as much anymore and hurts growth.

Lowered Dilution of the Markets

Here’s another strange phenomenon: there is decreased dilution of stocks in the markets. What does that mean? As time goes on, publicly traded companies like Apple, Microsoft, Boeing, whatever, they continuously issue out more shares of their company into the stock market. This means there are more pieces of a company out in the broad market to be purchased. This causes their prices to be marginally diluted and is overall good for the company.

The rate at which companies are issuing new shares has drastically dropped. You might be asking, “So what?”

When you invest your money, whether that’s in the TSP or in any other modality in your portfolio, you’re buying shares of companies that are available out on the public market.

When you invest in the C fund, for example, you’re buying a bunch of shares of companies all at once. When there is less supply on the market because companies are not re-issuing new shares, this causes a higher concentration of stocks in the broad market, and when institutional managers decide to rebalance the money they’re managing, they’re now moving massive swaths of the markets and driving the markets. This can be upwards, or this can be downwards.

And before I get the comment: “But Thiago there are millions of individual investors too.” I read somewhere that roughly 70% of all trades in 2020 were done by computers and algorithms created by institutional managers.

I don’t know how exact that number is, but it makes sense. If you think they can’t move the market, think again. Remember when I said the top largest companies make up $6 Trillion? Imagine what happens when dollars start leaving those companies and into other investments, or because people are using their dollars. Massive market swings.

Markets are not emotional

The next reason for this apparent fairyland we’re living in is the fact that the markets are not emotional. What do I mean by that? Investors are emotional. Money means a lot of different things to people, and humans are emotional beings.

When something happens, we have a reactive response, whether we do something about it or not, we still have a reaction inside of us. You have to understand that the markets don’t respond emotionally. Don’t believe me?

• Beginning of WWII – markets closed up 9% that week.
• JKF’s death – S&P500 had recovered their losses within 2 days of the funeral and finished the year up 17%…17 PERCENT, THEN up 15% and 11% the follow two years.
• Pearl Harbor – the DOW fell less than 3%.

I could keep going, there are literally dozens of examples like this2. Remember, it’s likely that more than 2/3rds of trading is triggered by algorithms that money managers programmed.

Professional money managers build rules based on math, and both technical and fundamental analysis of what’s going on in the economy. It’s not because we like the color on the new iPhone.

I heard someone once say that, “These rules aren’t sentimental. In the context of investing, these rules are fulfilling an obligation to whoever made them, and that obligation is profits.”

This certainly helps to explain the level of dispassion that we’re seeing in the markets these days.

Further, not only are the markets not emotional, but they also don’t lament tragedy. It’s always looking towards the next thing. What’s the next fed response, what’s the next company to go public, what’s the next big rebalance that makes a particular sector fall out of favor. And this can be incredibly shocking to investors who haven’t had a lot of experience with it.

What to do about it?

What should you do about it? There are positive things happening in the economy with stimulus, vaccinations, large companies pulling through, but there are also incredibly concerning indicators as well with the health of many other parts of “the market”.

When you hear the news talk about “the market”, they’re talking about the DOW, S&P500, big indices, and those are being driven by the big dogs. The underdogs are still suffering, and at some point, the markets will realize that.

If the all the markets did were to go up, that’d be a terrible thing. The US Dollar would become worthless relative to the other currencies, so we actually need the economy to slow down and reverse at times, and for the impending reversal, you need to be prepared.

We work with incredibly talented people who understand the importance of having a good plan in place so I’m sure this comes at a no-brainer. If you’ve read my publications or seen me speaking before then you’ll be no stranger to me saying that you MUST Stress-Test your financial plan.

Now, listen carefully: a market correction within a few years of someone’s plan to retire can be a massive torpedo to their retirement plan, and can cause them to have to push back their retirement date, sometimes by years. And I don’t mean a bear market, I mean a regular market correction.

For those of you that know me personally you know that I’m not an alarmist, but you need to be aware of this. I have seen this happen time and time again from people who come to us because they thought they were prepared to retire but had left themselves major risks in their plan.

And I’m not just talking about your portfolio. That’s a part of it, but you have to look at your financial plan as a jigsaw puzzle. There are many pieces that all fit together in the right way. Sure, you could mash pieces together and call it art but you’re not going to get the best results.

Healthcare planning is another big part that we often see people neglect. As a society, we’re doing really well in helping people live longer, but not necessarily healthier. This means you might have more years with higher health care expenses, and at the rate in which the cost of healthcare rises, that could mean you run out of money before you run out of time.

So how do you put all of these things to the test, your cashflow, your portfolio, healthcare planning, insurance, taxes, your goals, your legacy – and how to all of these things fit together? Well folks, that’s what financial planning is.

Make this the year that you stop just thinking about it and that you take action. After all, it’s not just your money, it’s your future. The things I talk about here are not intended as personal advice for you, so give us a call if that’s what you’re looking for.

1. https://adpemploymentreport.com/
2. https://stockcharts.com/