Sunday, September 08, 2019

Recession Talk Again

It seems much of the discussion and commentary recently is focused on an imminent recession partly precipitated by the consequence of an inverted yield curve. The recent recession chatter reminded me of an article I wrote a little over two years about a recession forecast and market bubble that was headline news in 2012. Yes, recession talk was headline news in 2012. The article included a table similar to the one below.

The above table includes several fundamental and sentiment data points. Since that 2017 article the S&P 500 Index is up 22% in an environment where S&P 500 operating earnings increased 33.6%. The growth in operating earnings has translated into growth in the market's earnings per share resulting in the trailing P/E remaining essentially unchanged at 21 times earnings. Forward earnings expectations have the forward P/E equaling 16.6 times versus the 18.2 times in 2017. With respect to the sentiment data, across the board, sentiment is less bullish today than in 2017.  These low bullishness readings are contrarian indicators; thus, a bullish sign for the equity market.

The last variable under the market data section in the above table is the equity risk premium (ERP). The ERP is the additional return above the risk free asset an investor requires to invest in stocks. For example, if an investor has a view that the market is under valued and likely to go higher, then one's view is the ERP will decline in the future. Conversely, if the investor has a view that the market is over valued and likely to go lower, then the investor believes the ERP will increase in the future. In spite of the advance in the market since 2017, the ERP has actually increased. A majority of the increase in the ERP is attributable to the decline in the yield on the 10-year U.S. Treasury bond. Nonetheless, as one evaluates investing in bonds and/or stocks, broadly, the equity markets are generating a much higher yield, earnings yield, than a 10-year Treasury.

Although the jobs report on Friday came in weaker than expectations, the economy is still creating jobs. Some of the economic data is signalling economic weakness, but on balance the data is more positive than negative. Earnings growth for the S&P 500 Index is expected to equal 11.2% in calendar year 2020. Of course this rate of growth will likely change, but continued earnings growth is expected. For investors, basing investment decisions on news headlines can harm a portfolio's return. Focusing on the actual fundamental and economic data is important so as not to make investment decisions based simply on emotion.

Finally I do not want to completely dismiss the potential implications of the inverted yield curve, however, a recession could come several years after the inversion if at all. Also, the S&P 500 Index is up nearly 19% year to date and investors should expect market volatility as year end approaches.

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