Q.ai - Powering a Personal Wealth Movement, Contributor
June 8, 2022
A common investing misconception is that the state of the stock market always reflects the state of the economy. Over the long term, this tends to be true, but over shorter periods, the two can become pretty disconnected.
The last couple of years have provided a perfect example of this.
- The stock market performed incredibly well in 2020 and 2021, despite a challenging economic backdrop
- There’s no real consensus on whether a recession is likely over the next 12 months, with economists and CEOs holding various differing opinions
- Regardless of the state of the economy over the next 12 months, there are some investments that will outperform, and some that will underperform
- As an investor, there are actions you can take to manage this risk
There's no denying that the Covid-19 pandemic has had a massive impact on various sectors of the economy. Companies went under, people lost their jobs and entire industries were shut down for months.
Despite this, the stock market went on a tear. The S&P 500 handed investors an 18.40% return in 2020 and followed this up with 28.71% in 2021. While it's no surprise that the lockdowns were good news for companies like Amazon, Google and Disney, it's pretty hard to argue that the economy was steaming along throughout those two years.
The stats also back this up. In 2020, GDP (economic growth) in the U.S. was -3.40% , including the worst quarter of economic growth experienced since 1948 at a staggering -9.10% annualized. The year 2021 saw a turnaround on these figures, but this was coming off the low base of the year before.
So we've established that the economy and stock market don't always march in step in the short term. Given that the stock market is choppy now, does that mean the economy is, too?
How are Americans feeling about the economy?
According to a recent poll from the Wall Street Journal, not good. With inflation being the overriding factor, over 80% of surveyed consumers described the economy as "poor" or "not so good." In a more personal take, over 35% stated that they felt unsatisfied with their own financial situation.
This is a trend that is going in the wrong direction. A CBS News Poll has been tracking Americans' views on the economy over the past 12 months. There, 69% of respondents stated that the current state of the economy is bad, compared to 46% in April 2021.
It's not difficult to see why. The cost of living is going up significantly, supply chain issues are still causing massive problems and, despite low levels of unemployment, wages aren't keeping up.
Does all the pessimism reflect reality?
Yes and no. The economy is a real mix right now. The labor market is very tight in certain industries, with some workers able to command significant pay rises and favorable benefits and conditions.
In others, conditions are worse than ever, with greater workloads being handed to employees by companies struggling to recruit. This issue tends to be in industries with lower-paid workers, where labor shortages are becoming increasingly common.
We're seeing a similar situation at a company level. It's no secret that the U.S. tech industry is suffering, with some huge falls seen in the stock price of companies like Netflix, Meta and Google in 2022. Other sectors of the economy are reaping the benefits of the misfiring system, with energy producers like Chevron and ExxonMobil, in particular, soaring off the back of record-high oil prices.
So there is good news and bad news depending on who you are and what you do, but what do the numbers say? Again, it's a mixed bag. They're not great, but they're not terrible yet either.
The first quarter of 2022 saw GDP fall for the first time since 2020, contracting by 1.51% on an annualized basis. A big chunk of this was due to how imports and exports are factored into GDP, and consumer spending actually grew by 2.7% on a real basis (adjusting for the impact of inflation).
For those in a healthy financial position, increased spending is likely to be eating into other financial commitments such as savings and paying down debt. While the effects of this might not be immediate, they'll be felt eventually.
The U.S. Census Bureau's most recent Household Pulse Survey has also found a 32% increase in people relying on loans and credit cards to meet their regular expenses and a 34% increase in those who have had to borrow money from family and friends.
However, with unemployment so low, companies have fewer workers available to fill their vacant positions. The available workers can afford to be more choosy. Usually, this type of supply-and-demand dynamic would mean wages would rise, taking the pressure off households.
A recession isn't guaranteed
A recession has traditionally been defined as two consecutive quarters of negative economic growth. However, there is a more complicated definition used these days. It's now up to the National Bureau of Economic Research to call when a recession has started. However, broadly speaking, two consecutive quarters of negative growth still indicate that things aren't great.
Despite all the pessimism and negativity around, we're not necessarily going to fall into a recession. Some sectors of the economy are performing well, and the low unemployment rate means that most people still have money in their pockets to spend.
The situation is further complicated by the Fed needing to walk a tightrope with interest rates, given soaring inflation. They may need to continue to raise rates to keep inflation in check, but this makes debt for individuals and businesses more expensive. Mortgage rates, for instance, are tied to overall debt yields.
There have also been strong words on the subject from the executives of some of the world's biggest companies. Jamie Dimon, the chief executive of JPMorgan Chase, stated in a recent interview that a "hurricane" is coming our way and that "you better brace yourself."
Another CEO who always has something to say, Elon Musk, has stated that he has a " super bad feeling " about the economy, announcing that Tesla would be laying off 10% of its workforce.
Others aren't so sure, with a recent Bloomberg survey of 37 economists putting the probability of a recession over the next 12 months at 30%. That figure is growing slightly, but it's a sign that an upcoming recession is far from certain.
All in all, it's a tough time for investors because we're getting some real mixed signals out there.
Investments that could win in a recession
As investors, it's essential to be prepared for any potential outcome.
There are always companies that are impacted more heavily when times are tough. The main factor to consider is whether a company's revenue will be affected by falling consumer spending. When household budgets are tight, luxuries get put on hold, and we tend to make do with the items we already have.
Automakers and electronics manufacturers, for example, might see reduced demand for their products. With less cash for vacations, the travel and leisure sector, such as airlines, might be under pressure.
On the other end of the spectrum, companies that provide goods and services that we can't go without can actually perform pretty well during a recession. Energy providers, discount retail, healthcare providers and supermarket chains are examples of businesses that fall into this category.
Suppose you're feeling more optimistic about the outlook for the stock market but want to hedge your bets. In that case, there are actions you can take if you don't want to try to pick individual stocks.
There are also opportunities to consider outside of the stock market. Precious metals such as gold have long been considered 'safe haven' assets, which can be attractive to investors during times of high inflation or market volatility.
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