Whatever the Future Holds Stocks Are Not Priced For A Recession ... How Will You Govern?

Old_Skeet

After reading the below linked article ... I began to ponder. How will I tweak my portfolio's asset allocation for the stock market rebound after the anticipated recession comes and stock valuations have declined?

https://www.bloomberg.com/news/articles/2019-10-06/whatever-the-future-holds-stocks-are-not-priced-for-a-recession

Since, my asset allocation is currently 20% cash, 40% income and 40% equity it will be pretty easy for me to play the equity rebound coming off of recession lows as my market barometer will assist me in timming my buys thus reducing cash as I move through the equity buying process. Then as stocks recover I'll move through an upside rebalance process.

Although my plan is simple ... Downside Rebalance Process followed by an Upside Rebalance Process.

I'm thinking it is best to have a plan over having no plan at all.

hank

Their estimated drawdowns seem reasonable: 30% fall in S&P likely. 50% drop possible. I disagree with their reference to last year’s market drop as a “crash.” I did not consider that 15-20% pullback late in ‘18 to be a crash - more like a burp or hiccup. The 50% drop possibility is only part of the story. How long does that new lower market level prevail? What follows? Those are what really matter.

Worst case for a retiree? Lose 30, 40 or 50% of your eggs over a couple years and than earn near 0 for several more years while continuing to take needed distributions. That would amount to a worse hit than a mere 30-50% drawdown alone would inflict.

I pretty much track my benchmark, TRRIX - a 40/60 balanced fund - give or take 1-2%. That fund generally clocks-in at about 1/3 the volatility of the S&P. So a 50% S&P drawdown should amount to roughly a 17% drop in value for me. But I’d be very slow rebalancing - a bit more cautious than Ol’ Skeet sounds.

Gary

What do you see causing (say 50%) drop in valuations?
I see stocks climbing a wall of worry at this time with all this pessimism coming from every everywhere which I think is good.

Any possible black swans?

hank

@Gary - Your question is beyond my pay grade except to say we’ve been in one of the longest economic expansions in history and 30-50% drops in various asset classes (including U.S. equities) have been known to happen before. So I think the possibility exists at this point in time. If you’re younger and in the accumulation stage that’s probably nothing to worry much about. As you accumulate new holdings you’ll be buying in at bargain prices should a substantial drop occur. I think where Ol’Skeet is coming from in posting this Bloomberg piece is that the rules of the game change somewhat when you cease accumulating and begin drawing down assets - especially late in a market cycle. So my point was that at that later stage of life (I’m 73) one needs to be cogniscent of the possibility.

What will cause the next severe market drop? I haven’t a clue. I don’t pay a lot of attention to P/E ratios or technical indicators as such. But, I’ll post some of the article’s reasoning below. Bear in mind that they’re only talking about possibility . I know from years of discussion here and st FA that the Leuthold investment group being cited is one of the more highly respected outfits and has made some good predictions before. I could go further and dig up 5 bearish prognosticators and link them, but for every one I could link someone else could come back and link a bullish prognosticator with equally compelling arguments. Bottom line: Nobody really knows - which is the reason we get paid to accept that kind of risk / uncertainty when we buy equities or lower rated debt rather than settling for 2-3% in money markets or government backed bonds.


Extended Excerpt: - (Bloomberg) - Nobody has a good record predicting the U.S. economy, not pundits and certainly not stock investors. And while a recession has been incorrectly forecast practically every day of the current bull market, when one finally comes it’s going to hurt.

Ten years of gains have fattened price-earnings ratios in U.S. stock benchmarks. Based on profits already booked, the S&P 500 currently trades at about 19.4 times income, while the Nasdaq 100 fetches 24.4 times. Those ratios arguably make sense during an expansion, especially when interest rates are so low. Should growth seize up, as it has shown signs of doing lately, look out.

“Large-cap valuations are high, not in bubble territory, but if we do stumble into recession over the next year, which I think is likely, I think we’ll see below 2,000s on the S&P,” said Doug Ramsey, chief investment officer of Leuthold Weeden Capital Management. “It’s very easy to get there. We don’t need to assume that you go back to old bear market lows.”

Extreme view? Yes. A decline like that would be 50% worse than the crash that landed on stocks a year ago. But outcomes like the one envisioned by Ramsey are why making odds on a recession can be the only calculation that matters for equity investors, who tend to enjoy gains as long as the economy isn’t contracting.

To get a sense of just how far stocks could fall, Leuthold plotted previous S&P 500 valuation troughs versus peaks using GAAP earnings per share. (In those terms, the S&P 500 now trades within the top 10% of readings.) At the bottom of 12 bear markets over the past 70 years, the multiple has spanned 5.6 to 14.4, the latter following the dot-com burst.

Even in a scenario where the multiple fell enough to correspond with the least-bad low in that study, it would take the S&P 500 just below 2,000, according to Ramsey. With the benchmark trading near 2,950 now, that’s a 32% plummet.

hank

Guilty of posting twice in succession. But Gary’s “Black Swan” comment got me to thinking. Almost by definition black swans are impossible to predict. But I recall about 5 years ago the question was put to the board by a member. My guess than was that the upcoming 2016 election might be deadlocked and end up contested similar to Bush v Gore. Didn’t happen. I was wrong. However, the 2016 results did serve as prelude to more turbulent politics in the country which might still result in a dark swan event going forward. Close - But being close only counts when tossing horseshoes and grenades.

Back to investing. There’s been a swan-dive in interest rates worldwide. IMHO these ultra low rates have bolstered equity prices. I don’t think rates can stay this low for many more years. So, a sharp reversal to higher rates globally might resemble something akin to a dark swan. Or maybe a turkey?

Time to take a bike ride.

Gary

I just put that out for us all to do some deep thinking instead of letting all the experts do the thinking for us.
Just my 2 cents.
Thank you

hank

Gary said:

I just put that out for us all to do some deep thinking instead of letting all the experts do the thinking for us.
Just my 2 cents.
Thank you

Yep - agree. My only “thinking” is I’d rather buy most anything and hold it when it’s priced at bargain basement levels. Bought a new pickup in ‘05 when GM put on a “fire sale” due to excessive inventory. Still own it. Was happy to go head-over-heels into some international funds in early ‘09 when many had shed 50% of their value.

Ol’Skeet’s “Barometric Reading“ strikes me as pretty deep thinking - but he’s into technicals.

Junkster

Markets tend to surprise more often than not so in that vein a contrarian could make the case that stocks will be much higher (over 10%) over the next year. Likewise the most crowded of all trades - the race to negative rates in the U.S. - will instead see the 10 year Treasury at yields approaching 2.50% to 3%.

Simon

I agree with Jeff Saut that this bull market has years, perhaps a decade or more, to run. So in August I bought more MFs for the long term. I also advised my wife to double her 401K and IRA contributions. We are 15 and 20 years away from retirement respectively and our stock/bond split is 90/10, so confident are we in the continuing bull market (which is only 6 years old after all). Jeff Saut wrote today...

"The S&P500 is consolidating. In a secular bull market, that's fashionable. We went through this from 2014 through early 2016. This is simply the 2018/2019 version. Every downturn and we hear from the recession camp and the bear market camp. How many recessions have been called in the past 18 months? I just laugh . . . and so does Wall Street. The fear mongers generate the emotional selling and Wall Street happily buys their shares. And when the news hits its ugliest level, the stock market takes off. During our last period of consolidation from 2014 to 2016, here's the GDP growth: 2014: +2.5%; 2015: +2.9%; 2016: +1.6%. The S&P 500 consolidated as we approached the slowdown but took off during the year that actually posted the worst GDP growth number. Why? Because the stock market is the best leading economic indicator."

Old_Joe

"We are 15 and 20 years away from retirement respectively"

@Simon- Given that fact I completely agree with your investment outlook. However, I felt that turning 80 was a signal for us to pull way back from our formerly robust market exposure. I hope that you have good luck and a good market run ahead. Even when the next major down cycle hits you should be able to buy in fairly cheaply and still have plenty of recovery time.

Gary

A lot of deep thoughts expressed from every one's place in life - I thank you for your different perspectives.

Starchild

Glad to read thoughts from long time investors here. I guess hindsight is the only way to examine markets, but it just feels that we've been in the slowdown, for we've had almost no market growth for close to 2 years, so I'm not sure where they're getting the 10 year bull market from. And why does everything have to drop 50%? Why this made up number?

I also feel many of these writers overlook the importance of record unemployment. With more workers, more money has to be put in the market every month with pensions and retirement plans. I can see more drawbacks happening as they always do, but hard to say a meltdown like 2008.

Old_Skeet

First, I'd like to thank all that have made comment. I enjoyed reading what has been written by those that made comment.

I found the article that Simon made reference to about Saut's comment. It is linked below.

https://www.marketwatch.com/story/the-bull-market-for-stocks-has-years-left-to-run-says-nearly-50-year-veteran-2019-10-08

I have followed Mr. Saut for years and value his perspectives. However, since I'm in the distribution phase of investing I'm not throwing caution to the wind; and, I have dialed the risk down within my portfolio over the past year or so. Hopefully, Saut is correct in his thinking as I'll make more in an up market than I will in a down market.

My current asset allocation is 20% cash, 40% income and 40% equity which I feel is about right for me now being 70+ years in age and retired. However, I do open special investment positions, from time-to-time, during downdrafts and then sell them off during the updraft.

However, you choose to climb the investment mountain I wish you much success. What I have done through the years has worked well for me and my family with some of my investing strategies being learned from my late father.

Skeet