Bad weather ahead: hurricane or drizzle?

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IIt was a stormy month for the stock market, but the sun finally came out and the Dow Jones Industrial Average rallied over 2,300 points before posting a slight gain (+0.04%) and the S&P 500 Index also posted an incremental increase (+0.005%). But there are clouds on the horizon. Although the economy is currently very strong (i.e. record corporate profits and a generationally low unemployment rate of 3.6% – see chart below), some forecasters are predict a recession in 2023 due to the Federal Reserve braking the economy by raising interest rates, in addition to high inflation, supply chain disruptions, COVID lockdowns in China and a war between Russia and Ukraine.

UNEMPLOYMENT RATE (1997 – 2022)

unemployment rate

TradingEconomics.com

But like meteorologists, economists are perpetually unreliable. While some doomsday economists expect a deeply destructive hurricane (deep recession), others see only a light drizzle (soft landing) developing. The truth is, no one knows for sure at this point, but what we do know is that the stock price correction this year (-13% now and -20% two weeks ago) has already been widely discounted ( taken into account) a slight recession. . In other words, even if a mild recession were to occur in the coming months or quarters, there could be very little negative reaction or consequences for investors. Similarly, if inflation begins to peak as it appears to (see chart below) and the Fed can orchestrate a soft landing (i.e. raise interest rates and cut balance sheet debt without crippling the economy), then substantial rewards could accrue to stock market investors. On the other hand, if the economy were to slip into a deep recession, history would suggest that this stormy forecast could bring another -10% to -15% chill.

INFLATION RATE (%)

Inflation rate

TradingEconomics.com

Due to billions of dollars of increased stimulus spending and the Federal Reserve’s quantitative easing (bond buying), we have seen an explosion in the government deficit and an increase in money supply growth (c i.e. the root cause of inflation). Arguably some or all of these accommodations were helpful in surviving the worst times of the COVID pandemic, however, we are now paying the price in exorbitant food costs, skyrocketing gas prices and rising card bills credit. The good news is that the deficit is plummeting (see chart below) due to reduced spending (due in part to the lack of Build Back Better infrastructure spending legislation) and the skyrocketing tax revenues due to the strengthening economy and capital gains in the stock market.

% GROWTH OF MONEY SUPPLY (M2) VS. GOVERNMENT DEFICIT

M2 money supply growth

Calafia Beach

For many investors, getting used to large multi-year gains has been very comfortable, but interpreting downward stock market moves can be very confusing and counter-intuitive. In short, trying to decipher the reasons for the market’s short-term zigs and zags is a maddening rush. Few predicted a +48% gain in the stock market during a global pandemic (2020-2021), just as few predicted a short-lived -20% reduction in the stock market in 2022 as we witness record corporate profits and unemployment rates near generational lows (3.6%).

Stock market veterans understand that stock prices can fall when current economic news is sunny, but future expectations are too high. Experienced investors also understand that stock prices can rise when current economic news may become too murky, but future expectations are too low.

Apparently, the world’s greatest investor of all time thinks all that gloomy recession talk is creating plenty of stock market windfalls, which is why Buffett has invested $51 billion of his money at Berkshire Hathaway (BRK.A) ( BRK.B) as the stock market has become much cheaper this year. So while the economy will likely face a number of headwinds in 2023, that doesn’t mean a hurricane is coming and you need to hide in a bunker. If you get out your umbrella and your rain gear, just like smart investors do in all previous tough economic cycles, the drizzle from the storm clouds will eventually pass and blue skies will reappear.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions and some exchange-traded funds (ETFs), but at the time of publication they had no direct position in BRK.B/A or any other security referenced in this article. No information accessible through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice and should not be relied upon in making any investment or other decision. Please read the disclosure language on IC’s contact page.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.


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