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Recession Outlook ➢ Impact of Recessions on Investments ➢ Conventional-Wisdom Investments for Recessions

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Recession Outlook ➢ Impact of Recessions on Investments ➢ Conventional-Wisdom Investments for Recessions Chap quoit A Division of Dynamic Portfolios Presentation of Managing the Risk of a Looming U.S. Recession During 2020 May 10, 2020 1 Chap quoit A Division of Dynamic Portfolios Impact of Recessions on Investments Virtually all recessions are accompanied by a large stock market drawdown. 2 Chap quoit A Division of Dynamic Portfolios S&P500 Daily-Close Maximum Drawdowns In Last 10 Recessions: 7 Bear Markets, 3 Corrections Black Monday 1987. Credit Crunch of 66. Computerized selling Long-Term Capital Flash Crash of 62. Liquidity Crisis in dictated by portfolio and Hedge Fund US Steel Price Bond Markets. insurance hedges. Redemptions Surprise. Bear Market Line Correction Line Shading represents US economic recessions as defined by the National Bureau of Economic Research (NBER). Chap quoit A Division of Dynamic Portfolios Managing 2020 Recession Risk Topics For Discussion ➢ Definition of a Recession ➢ Primary Factor for Declaring Dates for a Recession ➢ Historical Causes of Recessions ➢ Indicators to Help Estimate Timing of Recessions ➢ Current Recession Outlook ➢ Impact of Recessions on Investments ➢ Conventional-Wisdom Investments for Recessions 4 Chap quoit A Division of Dynamic Portfolios Definition of a Recession The National Bureau of Economic Research (NBER) Defines a Recession as: “A significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” Rule of thumb: Real GDP declines in two negative quarters. Official Recession Dates are declared by the NBER Business Cycle Dating Committee. -December 1, 2008, announced its most recent U.S. recession started December 2007, a full year after the recession began. -September 20, 2010, announced the ending of its most recent U.S. recession in June 2009, 16 months after the recession ended. -Beginning of the 1990-91 recession was announced one month after the ultimately- determined completion of the recession, completely missing the event. 5 Chap quoit A Division of Dynamic Portfolios First Primary Factor for Declaring Recessions Annualized Real GDP Growth Quarterly Percent Change in Real GDP Source: Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/A191RL1Q225SBEA, Retrieved: May 10, 2020 6 Chap quoit A Division of Dynamic Portfolios Second Primary Factor for Declaring Recessions Industrial Production Annual Percent Change in Industrial Production Source: Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/INDPRO#0, Retrieved: April 18, 2020 7 Chap quoit A Division of Dynamic Portfolios Leading Factors for Recessions • Monetary and Fiscal Policy Decisions • Trade Wars • Bursting of Investment Bubbles • Deflationary Influences 8 Chap quoit A Division of Dynamic Portfolios Recessions Lead by Monetary and Fiscal Policy Decisions Examples • Raising interest rates to fight inflation (1980) • Ill-conceived deregulation (S&L Crisis in 1990) • Wage/Price controls (1973-1975) 9 Chap quoit A Division of Dynamic Portfolios Recessions Lead by Trade Wars Examples • Smoot-Hawley Act 1930 – Originally conceived to protect agricultural prices. – The act raised tariffs on over 20,000 imported goods. – Exports were down 66% in 1933 from 1929 levels. • The Oil embargo of 1973-1974 was a trade war employing reduced exports by OPEC versus imposed tariffs. • Trade tariff skirmishes since 1950 had negligible impact on exports. 10 Chap quoit A Division of Dynamic Portfolios Annual Percent Change in US Exports Annual Percent Change in US Exports •Trade Resumption After WWII Auto Spat with Japan Chicken Spat Pasta/Citrus with Europe Spat with EEC Steel Spat with World • • • • • • 11% Increase in • • Worldwide Value of Dollar Great WWII Recession & Wood Spat Recession • with Canada Smoot-Hawley ++ 1930 Source: Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/EXPGSA#0, Retrieved: April 18, 2020 11 Chap quoit A Division of Dynamic Portfolios Recessions Lead by Bursting of Investment Bubbles Examples • Stock market crash of 1929 (1929-1933) – Only 10% Margin required to buy stocks • 1990s Dot-com bubble (2001) – Irrational investing in companies with no earnings • 2000s Housing price bubble (2007-2009) – Caused by lax lending practices for sub-prime mortgages and derivatives based on overvalued mortgage debt 12 Chap quoit A Division of Dynamic Portfolios Recessions Lead by Deflationary Influences Examples • Deflation -wait to buy at lower prices (1929-1933) • Dust Bowl droughts of 1930s dropped grain crop export levels and put farmers on unemployment. • Post-war drop in war materiel production – WWI (1920-1921) – WW2 (1945) – Korea (1953-1954) 13 Chap quoit A Division of Dynamic Portfolios Leading Indicators of Economic Activity That Assist in Forecasting Recessions • Expectations of Quarterly Change in Real GDP • Treasuries Yield Curve - 10 Year minus 3 Month • Treasuries Yield Curve - 10 Year minus 2 Year • Calculated Probably of a Recession • Change in Leading Economic Indicators Index • Consumer Confidence Differential – Expectations minus Present Situation 14 Chap quoit A Division of Dynamic Portfolios Anticipating Recessions Negative Yield Curve Spread (12-Month Recession Lag from Yield Curve Inversion) ? Failed Recession Predictions Source: Federal Reserve Bank of New York, https://www.newyorkfed.org/research/capital_markets/ycfaq.html#/interactive, Retrieved: April 18, 2020 15 Chap quoit A Division of Dynamic Portfolios Calculated Probability of Recession By Federal Reserve Bank of New York ? Probability of Recession Over 30% Failed Recession Correctly Predicted 7 out of 8 Last Predictions Recessions to Occur in 12 Months Source: Federal Reserve Bank of New York, https://www.newyorkfed.org/research/capital_markets/ycfaq.html#/interactive, Retrieved: April 18, 2020 16 Chap quoit A Division of Dynamic Portfolios Anticipating Recessions with Yield Curve 10 Year Treasury – 2 Year Treasury (12-Month Recession Lag from Yield Curve Inversion) ? Mid-Month (Aug 27, 2019) -.04% Source: Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/T10Y2YM, Retrieved: April 18, 2020 17 Chap quoit A Division of Dynamic Portfolios Reasons for the Yield Curve to Invert • Real Interest Rates are expected to fall. • Inflation is expected to fall. • Economic growth is expected to weaken. • An overly-tight monetary policy is in place. • Demand for long government bonds has increased. • Value of corporate bonds is expected to decrease. • Dollar is strengthening. 18 Chap quoit A Division of Dynamic Portfolios Leading Economic Index and Recessions Conference Board Consumer Leading Economic Index – LEI 6-Month Moving Average of 6-Month Rate of Change First Month of Recession Shown in Callouts Leading Economic Index Includes Average weekly hours, manufacturing Average weekly initial claims for unemployment insurance Manufacturers’ new orders, consumer goods and materials ISM® Index of New Orders Manufacturers' new orders, nondefense capital goods Building permits, new private housing units Stock prices, 500 common stocks Leading Credit Index™ Interest rate spread, 10-year Treasury bonds less federal funds Average consumer expectations for business conditions Source: Conference Board, https://www.conference-board.org/data/bciarchive.cfm?cid=1, Released: April 17, 2020, Retrieved: April 21, 2020 19 Chap quoit A Division of Dynamic Portfolios Consumer Confidence and Recessions Conference Board Consumer Confidence Expectations Minus Present Situation First Month of Recession Shown in Callouts Source: Conference Board, https://www.conference-board.org/press/index.cfm?pagenumber=2&sort=Date, Released April 28, 2020, Retrieved: May 10, 2020 20 Chap quoit A Division of Dynamic Portfolios Coincident Indicators of Economic Activity That Assist in Confirming Recessions • Actual Quarterly Change in Real GDP • Industrial Production – 12 Month Percent Change • ISM Manufacturing Orders Index • Advance Retail Trade Sales – Annual % Change • Unemployment Rate – Annual % Change 21 Chap quoit A Division of Dynamic Portfolios ISM New Manufacturing Orders Index First Month of Recession Shown in Callouts Source: Institute for Supply Management, https://www.instituteforsupplymanagement.org/ISMReport/MfgROB.cfm?SSO=1, Released May 1, 2020, Retrieved: May 10, 2020 22 Chap quoit A Division of Dynamic Portfolios Factors Confirming Recession (Annual Percent Change) Source: Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/RSXFS#0, Released April 15, 2020. Retrieved: April 21, 2020 (Annual Percent Change) Source: Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/UNRATE#0, Released: May 8, 2020, Retrieved: May 10, 2020 23 Chap quoit A Division of Dynamic Portfolios Real GDP Change Expectations Source Q1 2020 Q2 2020 Q3 2020 Q4 2020 Yr 2020 Goldman Sachs (Mar 31) -9.0% -34.0% 19.0% 17.8% -6.2% J.P. Morgan (Apr 9) -10.0% -40.0% 23.0% 13.0% -14.0% Morgan Stanley (Apr 3) -3.4% -38.0% 20.7% 15.2% -5.5% Conference Board (Apr 9) -5.8% -33.3% 0.1% 27.4% -6.5% Average -7.0% -36.3% 15.7% 18.4% -8.0% Sources: Publicly-available reports from the cited organizations. Year GDP Worst 2008 -2.5% Historical Years 1946 -11.6% Back to 1930 1932 -12.9% 24 Chap quoit A Division of Dynamic Portfolios Current Recession Outlook Dashboard of Leading Indicators for a Recession Recession Current Value Factor Comment Indication Value Date Real GDP -34.20% First Negative estimate Below 0 2Q 20 Change Expectations estimate of -7.0 In
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