FYI | May 16 2018
By Peter Switzer, Switzer Super Report
Only a recession could make me wrong on stocks!
In recent weeks I’ve advanced a number of investment strategies I believe are safe, medium-term, contrarian plays. I first argued that the top 20 stocks had been beaten up for too long and then I suggested that betting on a collection of financial stocks to make a comeback, post-Royal Commission, makes a lot of sense.
For the complete thrill-seeker you’d throw in AMP but you’d have to add this to your list of unsafe, contrarian plays. I do think David Murray will reinvent AMP but its potential for profit will change drastically as its business model is totally reworked.
I think the banks via tax cuts, a pick up in economic growth, eventual rising interest rates, selling of assets, such as wealth businesses (and our national past time of enjoying a drink, which means we have short-term memory loss) means bank share prices can edge up over time, while paying pretty good dividends on relative yield basis.
But what could bring me undone? What could prove that my overall view that stocks will rise for at least the next two years and that the top 20 stocks look like good value, is wrong?
I think that answer/threat is a recession, especially in the USA but I guess I can’t rule out a China-caused recession, because some smart guys do worry about our best export customer, though I think they’re wrong.
The year that should be the starting point for thinking a recession is coming is 2020. The Economist Intelligence Unit has gone on the public record tipping that year as a high risk year for a significant US economic downturn, undoubtedly based on the expectation that interest rates there will rise and choke off the pretty impressive economic recovery.
The Wall Street Journal’s Ben Leubsdorf has reported on a survey of private sector economists and the majority is worried about 2020 as well. Some 59% of the number crunchers went for 2020, 22% opted for 2021, while the rest opted for next year, 2022 and even beyond!
I recently asked Wespac’s chief economist Bill Evans if he agreed with the 2020 call and he rejected it, tipping it would be later. And that’s despite the fact that his view on the Oz economy is not as bullish as the Reserve Bank’s view on our economy.
If the Reserve Bank is right, and we see 3% plus growth over the next two years, then I think bank stocks, and the top 20 stocks, will ride up on a wave of growth and optimism. However, if we grow at slower rates and interest rates rise in late 2019, then it might be a short-lived spike for these precious stocks of mine before a damn recession KO’s the share prices.
And if one is coming in 2020, the stock market will sell off ahead of the recession and I could be proved wrong. So I need to see good reason to believe that a recession is a 2021 or 2022 event, or even later.
I could hide behind that great quote by the legend of economics, John K. Galbraith who once said: “In economics, the majority is always wrong”. This was an exaggeration and Galbraith probably said it with a bit of cynical humour thrown in, but I’d say the majority is often wrong.
The Wall Street Journal survey revealed that 62% of the economists expected an overheated US economy as the cause of the recession, so that puts the ball back into the camp of the Fed and its new boss, Jerome Powell. So far, he has looked measured when it comes to rate rises and last week’s reasonably low inflation numbers could keep him from making too many rate rises this year.
Three or four rises are expected in 2018, but if inflation remains low, then those who argue that this recovery will be slow and drawn out, because of very low interest rates and the dual impacts of globalisation via the Internet and digital disruption, could be proved right.
I’m kind of in this camp but I can’t blindly ignore what the Fed does with rates and the story is made more complicated because President Trump has pushed up the Yanks’ Budget Deficit to worrying levels and this could create the overheating factor, even if the Fed plays a cool-headed game.
Bloomberg says the “deficit will surpass $1 trillion by 2020, two years sooner than previously estimated, as tax cuts and spending increases signed by President Donald Trump do little to boost long-term economic growth.” That’s the view of the Congressional Budget Office (CBO).
The CBO has estimated that real GDP will grow by 3.3% in the 2018 calendar year, before slowing to 2.4% in 2019 and 1.8% in 2020, based on the fourth quarter year-over-year figure.
“During the 2020-2026 period, a number of factors dampen economic growth: higher interest rates and prices, slower growth in federal outlays, and the expiration of reductions in personal income tax rates,” CBO said.
What is interesting is that the CBO, which has been pretty critical of Trump’s policies, is not seeing a recession even in its 2020 to 2026 assessment. Last year, Tom Lee, of Fundstat Securities, a highly regarded US business TV commentator, said this bull market could go on for 11 more years!
He’s gone too far but even he was half right, it would mean a recession is delayed beyond 2020.
I find this chart quite supportive of my view that we are living through unusual economic times when the old rules and theories of economics are under challenge.
Very low interest rates only have happened when recessions have occurred and then they would take off until they got so high that they created another recession, as the chart below shows.
This shows US interest rates have been nearly as low before but they didn’t stay low for long. This economic recovery has kept (and needed to keep) rates lower for longer so it’s very possible that the recovery itself will be slower and longer than before.
I will be watching the passage of US interest rates to see if I have to become a 2020 recession believer. For now, I’m investing in my contrarian plays because even if I’m wrong, most of them are good dividend payers, even in a recession! Safe investing is my mantra, where contrarian plays on blue chip companies beaten up by the market often works out.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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