Thoughts On ... The Benefit of the Doubt

February 13, 2023 | Matt Barasch


Let’s start with a sagely phrase from one of the legends of our business - “If there is no U.S. recession on the horizon, give equities the benefit of the doubt.”

While simple, it’s a sound strategy for investing as markets - whether within the U.S. or without - will tend to rise when the U.S. economy is rising (not in recession) and fall when the U.S. economy is stumbling.
To put some numbers around it - since 1945, the stock market has risen about 80% of the time in a given year when there was no U.S. recession, and only about 30% of the time when there was a U.S. recession.
With that in mind, let’s take a look at a chart and then comment:

Here we are looking at a recession scorecard that our investment strategy committee puts together on a monthly basis. As you can see, while some of the indicators continue to flash green, several have turned red.
Our view is that a U.S. recession is a likely outcome for 2023. While all the indicators do not point in that direction, if we look beneath the hood on some of them, there are signs of deterioration.

Further, we find ourselves at a unique point in history. Normally, when there are signs of deterioration in various economic metrics, we will see central bankers stepping-in to try to re-stimulate the economy. They do so by cutting rates, which will tend to stimulate borrowing and investment - both of which are integral to economic recovery.

But the current backdrop is different. Central bankers led by the U.S. Federal Reserve are not looking to re-stimulate the economy, despite the slowdown, and are instead still tightening policy, which will further slow down the economy.

As we have discussed numerous times over the past couple of years, the bogeyman for central banks is inflation and the risks that it will become entrenched. This occurred in the 1970s and early 1980s and it contributed to a decade of low real growth and general economic malaise. In order to beat back inflation, central banks view an orchestrated economic slowdown as the only way to guarantee success.
While there are many causes of inflation - at its simplest it is too much demand for not enough supply. Supply lines were cut by COVID, demand for stuff was electrified by too much stimulus, supply lines were further damaged by the war in Ukraine - demand needs to be forcibly pushed down to give supply and demand a chance to balance. Raising interest rates will ultimately push down demand and achieve this balance.
Returning to the recession question - we think the U.S. Fed is likely to get what it wants. This is not the end of the world for stocks, but it is likely to make 2023 a challenging year (despite a strong start).

Good businesses will weather whatever storm the central bankers can muster, so we tend to view these type of backdrops as opportunities to add good businesses at distressed prices. In a sense - we always give good businesses the benefit of the doubt.