Before the March edition of this newsletter arrives in your email in-box, I will have turned 50 years old. Being on Cape Cod, you can sort of live in denial about your age. When my wife and I go out to eat for example, the majority of the people we see at the other tables are our age or older. This was true of the gym I used to frequent, the church I attend and even at work where somehow in my 27^th year with Keeling Financial I’m still the youngest person in the office. Of course, this makes sense. According to the most recent census, the average age in Barnstable County is 53.4 years, so I am still younger than the majority of people who live around me – at least for another few years. But the reality is, I’m not young anymore. The median age in the Country is about 38 and when I go out to dinner in Boston – where the median age is only 33 – I often find I’m the old person in the restaurant. But of course, with age comes experience and hopefully wisdom. As the markets started off 2022 with a pretty quick and notable sell-off, I began to think about all the wild things that have happened in the U.S. economy over my 27 years in this industry. Sure, the current pandemic is unprecedented, at least in the last century, but a lot of unprecedented things have happened in these nigh three decades of my professional life. From terror attacks, to Y2K, to the invention of the smart phone and social media – all things for good and ill that happen in our world have their own unique features that allow us to use the “unprecedented” label. How then, do we put what is going on now in perspective? What do we look for over the coming months to know if we should keep to our standard level of awareness or if we need to take things to Defcon 4? 

Ultimately, the stock markets do reflect the overall economy. This is why I’ve been warning about the markets being too high recently, because the prices of stocks have risen faster than the underlying earnings of companies over the last several years. These dislocations tend to correct themselves; this is why it’s called a “market correction.” But how bad things get, how deep that correction goes, seems to correspond with where the overall economy happens to be. If economic growth is positive, these sell-offs tend to be short-lived because they can quickly get valuations back into line. If, however, we are entering or in a recession when the markets have a sell-off, those sell-offs tend to last much longer. So where are we? In January the S&P 500 saw a return of -5.17% and most other major indexes also saw negative returns. But the largest downturns happened to be in the areas of the economy that had the largest gains and the highest prices compared to their earnings. For example, if you break the market down into growth and value stocks, going into the year the price to earnings ratio (or P/E ratio) of the Russell 1000 growth index was over 35, while the P/E ratio of the Russell 1000 value index was only about 17. (The higher the number the higher the stock price vs. the earnings of the company.) For the month of January, the aforementioned growth index went down 8.54%, while the value index went down only 2.33%. We see similar things in other indexes, the more overvalued indexes saw the largest declines. This is a true ‘Correction’, correcting the prices closer to where they should be and it’s overall a healthy thing. If we keep having positive economic growth, then these valuations are also helped by the underlying companies making higher profits. If the P in the P/E ratio goes down somewhat, and the E goes up – then we suddenly have a less overvalued stock market and hopefully only a short and mild downturn. 

In recession things are different. In a recessionary period, the earnings of companies are dropping, so the market has to drop that much more to get valuations in line. I don’t want to make it sound like it’s all an easy formula based on P/E ratio because it’s certainly not. The behavior of people ultimately determines the market movements and that behavior differs wildly depending on the overall economy. In a good economy where people are employed and have incomes, where companies feel their earnings are going to be positive, when the markets sell off there are often dollars waiting there to buy back in at what they hope are better prices. During a recession, when people are laid off or worried about their employment and when corporations start hoarding cash to ride out a bad economy, there often isn’t anybody to buy back in even when the markets reach valuations that seem extremely attractive. This is why we tend to over correct during bear markets that combine with recessions and get worse outcomes over longer periods. Add in a credit crisis (which there is no current sign of) and you get 2008-2009. 

We will of course have a recession again at some point in the future. But in the short-term, we just posted 2021 GDP growth at 5.6% - the highest in almost 40 years. The Fed is going to raise interest rates, which is designed to put a damper on inflation – but they need to raise them 4 times just to get the Fed Funds rate to 1%. It’s possible borrowing costs don’t actually go up at all for the first six to nine months of the Fed raising rates. This means it’s very unlikely (of course not impossible) that we see a recession in 2022. Even a slowing economy and rising rates would take some time to work their way through our enormous economy, pushing off that possibility at least until next year. Truly, finally, get Covid behind us so the service economy can grow the way the product economy has over the past year – and we could push that off even further. A market correction without a recession is a great time to rebalance, blow out of taxable positions you don’t want to be in anymore with less of an IRS bite, and make sure you are properly positioned for the future. Because growth doesn’t always outperform value, in fact studies show value outperforms more often. So, if your portfolio went down more than the overall markets last month – maybe you need to reassess where you should be long-term. 

I’m not upset to be turning 50 so much as amazed. I swear the years between 30 and 50 went by in half the time the years between 22 and 30 went by – and one quarter the time I was in high school and college. But I guess everyone feels that way. During those 50 years we’ve seen seven recessions, if you can even count the quick whiplash that struck us when COVID first hit in 2020. I’m caught between not wanting to see anymore recessions and hoping I live long enough to see another seven. But I just don’t think the next one is going to be this year. With that said, you should always make sure you have enough of your assets accessible for the short-term if I’m wrong. If you know anybody who isn’t sure if they’re positioned correctly for whatever the future brings – we’re accepting new clients. Talk to you next month from the other side.