Markets declined for the week as of today’s close. The S&P 500, DJIA, and NASDAQ were all down 2.10%, 3.31%, and 1.35%, respectively. Earnings from large banks took center stage with mixed updates. Big banks warned the economy to prepare for a possible recession despite decently strong earnings buoyed by higher interest rates. We’ve been paying close attention because banks are one of the first companies to feel any economic changes coming. Banks have been warning us that they are preparing their own companies for a mild recession this year.
So, after a painful 2022, is America destined for an eminent recession? That’s a scary thought! If stocks can fall double digits without a recession, what could happen if we actually have one? If bank CEOs are preparing for a downtown, how are we preparing portfolios for one? We cannot avoid a recession; we can only prepare for one.
Our base case going into this year is that America will likely have a modest recession in the near future. However, that “near future” continues to be pushed out given the continued strength of the consumer. Headlines of mass layoffs at tech giants have not impacted the broader job market and has remained surprisingly strong. The other reason consumers have remained so strong is the huge amount of savings we’ve built up during COVID-19 pandemic (see shaded blue area below). Those savings have been coming down since 2021 as Americans cope with high inflation, but we still have a tremendous amount of cash on the sidelines, almost a trillion dollars. As long as this cushion lasts, it could stave off a harder landing for the economy.
Since the American consumer is more prepared to handle a recession than during past cycles, we don’t foresee an economic crisis like in 2007-2009. During the Great Financial Crisis (GFC) there was a systemic breakdown of the financial system. Banks were closing shop and we were worried if we could get cash out of ATMs. Today (outside of some cryptocurrency investors), the system has proven quite resilient; we have not seen a surge in bankruptcies. I also don’t foresee a crisis like the “Tech Wreck” in 2001. Some extremely highly valued unicorn companies have come back to Earth, but we’ve been lucky to sidestep that mess.
For Apriem, navigating through a recession (mild or not) requires a three-pronged approach:
- Strategic asset allocation
- High-quality, high cash-flow domestic stocks
- Conservative fixed income
For most of our strategies, we continue to be slightly overweight or at weight in equities. Our investing time frame is five to ten years out, so we look past these short-term economic issues. Domestic companies and the broader economy are still extremely attractive. That is where we are going to find innovation and better growth opportunities. A recession is coming, but it’s not a guarantee it will be this year. It might come in 2024 or 2025 or not at all. When a recession does come, we think a diversified basket of high-quality, large domestic companies would be best poised to withstand that turbulence. The companies we invest in generally have strong cash flows and/or operating margins that are better positioned to deal with an economic storm than unprofitable start-ups. If your time frame is measured in years and not months, stocks could still offer the best growth opportunities but with many risks in the short term.
On the fixed-income side, we continue to stay short and safe. We started to be concerned about inflation back in late 2020 and have been moving our bonds to more short-term maturities. Long-term bonds were hit harder last year when interest rates rose, but they have stabilized as of late. But now looking forward, yields on many high-quality bonds are around 4-5%. So, locking in today’s high rates may look compelling depending on your outlook. That may provide some haven from the volatility of the stock market.
Join us for next week’s webinar where Apriem’s Investment Team and I will be discussing these topics and answering your questions. The webinar will take place on Wednesday, January 25, 2023 at 1:00pm. If you have not registered to attend click here to register and learn more.
Benjamin Lau, CFA
Chief Investment Officer & Principal