Summary
- Stocks “finally” corrected
- The Federal Reserve was right to pause
- A U.S. recession is unlikely
- Investment opportunities are still plentiful
It took over three years to happen, but in August a 10%+ correction finally struck U.S. stock markets. We say “finally” because we’ve been waiting patiently for new investment ideas to come to us, building up a double-digit percent cash balance. Now that securities are at lower prices–some stocks substantially so–than they were just months ago, investors are leery to act. We concede that there are plenty of reasons to hesitate, but we’re putting capital to work. The economic landscape in the U.S. remains favorable to equities and more importantly, ample long-term investment opportunities exist.
Like some investors, the Federal Reserve has adopted a wait-and-see approach. During last week’s Federal Open Market Committee (FOMC) meeting, the Fed surprised markets (a recent Wall Street Journal survey showed 82% of economists expected a hike) by not raising interest rates. They made the right call.
While the U.S. economy has indeed recovered from the abyss of the 2008/2009 recession, it is by no means at risk of overheating. Energy market turmoil and a strong U.S. dollar have seen to that. Corporate profit growth has stalled. Industrial production, manufacturing, and durable goods orders are all extremely weak. It gets worse overseas.
International economies, in particular the emerging variety, are struggling under the weight of weakening Chinese growth, low commodity prices, and currency pressures.
Amid the economic slack in the U.S. and the potential downside risks from international economies, the Fed held rates steady, likely to buy more time for threats to either develop or to dissipate in the coming months. And why not hold steady? Inflation is negligible and financial conditions have already tightened–high yield bond spreads are up over 250 basis points in little over a year. The Fed believes the weakness is transitory and hopes to raise rates in December. We think both are likely.
In the meantime, the widespread concerns are creating investment opportunities. If the fears turn out to be warranted, and China does in fact push the U.S. and the rest of the world into a recession, then stocks will likely go much, much lower. But there is a strong reason to doubt that bearish assessment: U.S. economic data is strong in all the right places.
Single-family housing starts, while relatively low by historical standards, are growing at nearly 20% year-over-year. Auto sales are strong. Layoffs and unemployment claims are at historical lows, while employment continues to expand. Incomes are rising and consumer spending is firm. There simply hasn’t been a recession in the United States when these kinds of economic conditions existed. And recessions have caused the vast majority of bear markets, as we detailed here and here.
If a downturn is right around the corner, one that arose without economic excess and limited signs of warning, it will be an anomaly. The historical telltale signs of recession, which generally provide warnings 6 to 12 months out, aren’t yet flashing a cause for concern. Long leading indicators, which have provided warnings 12 to 24 months ahead of a recession, aren’t signaling concern either. And that’s why we’re buyers.
Put simply, the market correction has created opportunities to invest in individual companies with long-term double-digit return prospects and the U.S. economy is still good where it counts.
