https://www.wsj.com/articles/recessions-investments-best-wor…
**Which Investments Do Best—and Worst—in a Recession**
**We ran the numbers for seven recessions, and found a big difference between what fared well in the period leading up to recessions and during the recessions themselves**
**By Derek Horstmeyer, The Wall Street Journal, Sept. 2, 2022**
**...**
**We studied the seven recessions in that period (1973-75, 1980, 1981-82, 1990-91, 2001, 2007-09 and 2020) and found that growth stocks led the way in the lead-up to recession. But, once we entered a recession, fixed income far outperformed equity, with international stocks providing the worst returns by far....**
**The asset classes we examined were U.S. high-yield bonds, U.S. long-term bonds, U.S. short-term bonds, U.S. total fixed income, U.S. growth stocks, U.S. value stocks, U.S. small-cap equity, international equity and U.S. large-cap equity....**
**In a recession, U.S. total fixed income averaged a monthly return of 0.62% (7.7% annualized), while U.S. growth stocks returned an average of 0.12% monthly (1.5% annualized). Returns were negative for every other equity class we studied....On the equity side, international equity was easily the worst performer in a recession, at negative 0.93% a month on average (minus 10.6% annualized)....** [end quote]
All seasoned METARs have observed that the stock market falls during a recession.
When the markets were relatively free of Federal Reserve interference, bond yields normally fell during recessions (which caused rising bond prices, since yields and prices move opposite to each other). Businesses and consumers usually borrow less during recessions and the lower demand for borrowing caused the yields to fall. The late market analyst, Louis Rukeyser, used to talk about “bond ghouls” since bond investors preferred recessions to boost the value of their bond portfolios.
As we all know, the Fed has recently been raising the fed funds rate (which they kept at zero far too long, exacerbating the inflation that was caused by excess fiscal stimulus and many other factors). Fed Chair Powell was very clear that the Fed will keep raising the fed funds rate even if a recession ensues until inflation recedes to their preferred level of 2%.
Regardless of stock market hopeful speculators, I believed the Fed and sold (most of) my stock holdings in early 2022.
The market is now in an unusual situation where bond yields are rising even though the economy is intended to slow, possibly (though not necessarily) into recession.
https://stockcharts.com/freecharts/candleglance.html?$IRX,$U…
https://stockcharts.com/freecharts/yieldcurve.php
HYG is a high-yield bond fund. High-yield (junk) bonds act more like stocks than like Treasuries since the recessions that reduce cash flow also reduce the ability of zombie companies to pay the interest on their debts and raise the risk of default.
The rapidly rising Treasury yields cause the value of $31 Trillion in outstanding Treasury debt to fall. Like all bonds, Treasury values fall by 1% for every 1% rise in prevailing yields multiplied by the remaining duration of the bond. Individuals, institutions, foreign countries and even other government agencies (and the Fed itself) are watching their bond balance sheets fall. This is different than earlier recessions when bond values usually would rise, counteracting the fall in stock prices.
https://fiscaldata.treasury.gov/datasets/debt-to-the-penny/d…
They say, “Don’t time the market.” This is true for the bond market as much as the stock market. The only two dates that a stock investor should care about are the day they bought the stock and the day they sell the stock. This is similar to bond investors. However, bond investors have the choice of holding a bond to maturity, in which case they are guaranteed return of principal. (Assuming the borrower doesn’t default.) I ladder my bonds (and CDs) and always hold to maturity.
I think that the speculative fever is still raging in the stock market. This is shown by the rise in the stock indexes today based on a jobs report that matched economists’ expectations. The stock market is far from capitulation.
When interest rates are expected to climb, it’s best to stay short-term for flexibility. Once interest rates seem to have peaked, cash can be split between longer-term bonds and stocks (which will grow faster but also be more volatile).
Inflation is an important issue for all investors, especially bond owners who get fixed coupons. TIPS yields are rising parallel with Treasury yields. Secondary-market TIPS are yielding 0.9% in the 5 - 10 year maturity, close to their 10-year average. (Way up from the negative yields of the past few years.) The market still believes that the Fed will succeed and that inflation will stay at 2.5% for the medium term. Macroeconomic factors could weigh in either direction on inflation. The aging population is deflationary. But rising future government spending is inflationary.
https://fred.stlouisfed.org/series/DGS10
https://fred.stlouisfed.org/series/DFII10
https://fred.stlouisfed.org/series/T5YIFR
It’s possible that the Fed will not be able to quell consumer price inflation, which is more directly affected by fiscal than monetary action. Monetary policies more directly impact asset prices than consumer prices.
We could end up with stagflation. If inflation stays higher than the bond market currently expects, TIPS would be a better choice than Treasuries. (TIPS are currently yielding above I-Bonds, but several factors make I-Bonds a better – including the fact that I-Bonds always return full principal, regardless of interest rates, whenever they are redeemed. If TIPS are sold in the secondary market before maturity they would sell at a discount if interest rates rise.)
The recession, if there is to be one, has not yet started but is likely within a few months.
https://fred.stlouisfed.org/series/T10Y2Y
Stock prices almost always bottom several months into a recession, not at the start. Stock prices in the 2000 recession (whose dot-com stock bubble resembled our tech “high-growth” stock bubble) didn’t bottom until early 2002, after the recession ended.
https://www.macrotrends.net/2324/sp-500-historical-chart-dat…
Many investors don’t try to time the market or tune their investments. Those who do might consider staying out of stocks during the coming recession, then re-entering when the Fed begins to cut interest rates. That would also be the time to change from short T-bills and cash to some longer-term bonds to lock in the highest rates of this cycle.
Wendy