We wanted to take the opportunity to answer some questions we have been asked by our clients and friends recently as the investment climate has changed over the past few months. The article describes where we believe we are in the current economic cycle, where we may be headed, and what we are doing to help.

1. Are we in, or heading towards, a recession?

It is not knowable with certainty whether we are heading towards a recession. That said, there is certain information we believe is important to understand:

• While the media and other sources often refer to and speculate about a possible a recession, it is important to remember that in economic terms, a recession is identified as two consecutive fiscal quarters of negative GDP growth. This is not where we are today.

• Recessions are a normal and natural part of an economic cycle. Since World War II, there have been 13 recessions with the last two in 2020 and 2008. On average they last 6-8 months with 2008 lasting 1 year and 6 months (the longest) and 2020 lasting 2 months (the shortest). The longer we go without a recession, the greater the imbalances in the economy become and when we eventually do experience a recession, the harder the fall will be. Recessions are a natural and inevitable correction of discrepancies that are economically unsustainable. Our current economy has many imbalances that need to be corrected - we have seen valuations soar for companies that don’t generate profit, first time home buyers unable to participate in the housing market without significant financial assistance from family, and disruption in the global supply chain with unprecedented consequences. The status quo has clear imbalances and market forces are working to correct these imbalances.

• Once we are officially in a recession (i.e. have experienced two consecutive quarters of negative GDP growth), the majority of market decline would have already occurred. The market is forward thinking, and stocks/business valuations will have priced in the full extent of a recession long before a recession is at its worst. Accordingly, a portion of the current decline is pricing in the possibility of a future recession.

• Whether or not we are headed into a recession, we know that as owners of great businesses, we own a portion of the future cash flow that each business generates. John Pierpont Morgan (the founder of J.P. Morgan) said “In bear markets, stocks return to their rightful owners. And in recessions, we find out who those rightful owners really are.” The stock market, depicted below between 1928 and 2022, does not go up in a straight line. While at times non-linear in the short term, the clear trend over time is up and to the right. 

Source: www.multpl.com

2. What are you doing to help us?

• First, we always try to make sure that our clients have cash or cash equivalents available. This is so we don’t have to sell businesses that have been purchased for you for long term appreciation. Having savings set aside helps prevent the temporary worry associated with natural market declines. To be clear, if you require funds in the near term (i.e. within a 2-year period) these funds should not be in the market. Remember, the markets are unknowable in the short-term and inevitable in the long term as illustrated in the chart above.

• Second, we keep our emotions in check during these more challenging times. Investment plans are well thought out strategies that are conceived, developed and implemented thoughtfully and emotions can erode rational thought. If you are feeling uneasy about the markets or your accounts, please call us – that is what we are here for. We recommend that you ignore the daily drama in the financial news. The media wants readership. 

• Third, we view these markets as opportunities to upgrade the quality of the businesses you own. Despite our best efforts, not every business we buy for you will prove to be a good investment. Sometimes the industry, market forces or regulatory frameworks change and sometimes we are just wrong. Nevertheless, these periods of depressed prices provide an opportunity to remove those businesses and replace them with other businesses, ETFs, or funds. We are always looking to buy great businesses at discounted prices.

3. When will the markets stabilize?

“The cornerstone of rationality is an unbiased appreciation of uncertainty.” – Daniel Kahneman, author of “Thinking, Fast and Slow.”

• To provide truly objective and unbiased advice, we must first acknowledge and appreciate the inherent uncertainty surrounding many of life’s events and decisions. The past two years have certainly proved that to be true. So, we don’t know when the volatility will end, we don’t know when the market will stabilize, and we don’t know what catalyst will eventually reverse the downward trajectory. No one does.

• We prefer to provide advice and guidance within a framework that we do know. We do know that the last 5 years have been uncommonly rewarding for investors (other than the blips in December 2018 and 2020), that temporary declines are the price investors pay for long term appreciation, and that these temporary declines are not comfortable. The chart above should provide comfort that declines are temporary and good businesses remain good businesses before, during and after a recession.

• We have seen periods like this before and we know there is a winning formula - staying invested in high quality companies, diversifying your portfolios with businesses that react differently in different markets, and, most importantly not letting your emotions rule your decision making.

Please don’t hesitate to reach out to any member of our team as we would be happy to speak with you.