Despite the lack of correlation between equity markets and
economic growth, de-risking before a recession can help investors avoid large
losses.
Sorry for the delay, but have been out of the country only
to return and have a presentation to put together. Luckily the presentation yielded much
commentary level material. The first of
which I want to cover is why recessions matter.
Most probably view this as common sense, but the reality is
often times the market and the economy don’t run in sync. For example, the market bottomed in Q1 of
2009, but the economy was still very weak.
Recently, GDP growth for much of 2013 was lower than that of 2012, but
the market basically doubled its return in 2013 from 2012.
Anyway, by and large is that economic forecasting shouldn’t
be a huge factor in determining how you allocate your portfolio. Aside from being terribly unreliable, even
when they are spot on the market may behave in an unexpected way. I agree with that for the most part, except
when it comes to recession forecasting.
Here I walk through why:
- A reduction in corporate profits often leads or
coincides with recessions.
- As one would expect, profit growth is highly correlated with
the S&P 500. Also, that larger
market declines happen when earnings fall at or around recessions:
- Thus, it follows that if economic growth is positive, as it
is projected to be, earnings should grow and subsequently the market.
- But more importantly, if you have a beat on when the economy will slow (and that is very hard to do) you can get out in front of a fall in corporate profits and the subsequent fall in the market.
The
takeaway is to use economic forecasts as part of your risk control strategy to
move out of stocks before they have a large move down. But don’t have it be your only piece and
certainly don’t go risk heavy because the economic growth is expected to rip as
there are other factors at work. This is
a drawn out way of saying “win by not losing big” and seeing storm clouds on
the horizon can help with that.
The views and opinions
expressed herein are those of the author(s) noted and may or may not represent
the views of Capital Analysts, Inc. or Lincoln Investment. The material presented is provided for informational
purposes only. Nothing contained herein should be construed as a recommendation
to buy or sell any securities. As with all investments, past performance is no
guarantee of future results. No person or system can predict the market. All
investments are subject to risk, including the risk of principal
loss. S&P 500 Index is an index of 500 of the largest exchange-traded
stocks in the US from a broad range of industries whose collective performance
mirrors the overall stock market The Dow Jones Industrial Average is a
widely watched index of 30 American stocks thought to represent the pulse of
the American economy and markets.
