Day 219: Scheduling a Recession Part 4

Mother's Little Helper portfolio was UP today +$6,837.28 (+0.88%). Overall GAIN YTD: +$197,355.46 (+33.80%).

According to CNN Money our benchmark index, the S&P 500 is up +10.42% Year To Date.

http://money.cnn.com/data/markets/sandp/

Blue line = MLH, Red line = S&P 500

In this installment I'm taking a look at interest rates and how raising and lower rates correlates with recessions. If you accept that interest rates are the sole or primary factor that initiates a recession than the chart below will tell you that the clock started ticking this year with the last rate hike from the FED.

In the chart below the pink bars represent the first interest rate hike prior to a recession, the green bars are the recession. However there is more than just a causal effect of raising interest rates. The chart below also shows U.S Gross Domestic Product (GDP) on a 5 year average, the gold line. Gross domestic product (GDP) is a monetary measure of the market value of all final goods and services produced in a period (quarterly or yearly). Note that from 2008 to 2013 the U.S has experienced the lowest level of GDP at any time shown on the chart and is just now averaging right around 1978 levels. Raising interest rates in and of itself doesn't appear to have a huge impact on the economy but raising rates from very low GDP growth levels appears to trigger the clock. Maybe it's better described as the 'snooze button' as the time frame from the first rate hike to the actual recession runs from 3-9 months.

Taking this set of data points by itself we should be entering the next recession very soon. The first rate hike by the Fed in this cycle was on December 14, 2016. Using the averages of the past we should have entered a recession by mid-March 2017 or by Mid-September 2017. So I said it, a recession should be here in September. Not so fast, averages have a funny way of clouding our thinking and I'm not convinced that GDP and interest rates alone are the only factors to consider. Look at the chart below and note that only in periods of low GDP have we seen a recession follow soon after the first rate hike. But we've never had a set of condition like we have now, so predictions based on past events are...tricky.

When rates were hiked in 1963 the recession didn't arrive until 1970. Plus there were many other factors that simply didn't exist in previous cycles. For instance, trillions of dollars in overseas cash awaiting repatriation with a simple tax break. The Fed with $4.5 Trillion in assets on its balance sheet, much of it sub-prime mortgages. Strong corporate earnings in an otherwise difficult, low growth economy. Low unemployment. The looming anticipation of a complete overhaul or at least a break in personal and corporate taxes.

While the stock market continues to set new records based on corporate earnings strength, keeping optimism high, there are a couple of other factors to consider. Retail investors tend to enter the markets late, a condition known as FOMO or Fear of Missing Out. With retail investors now entering the market with record inflows, professional investors are beginning to consider that the market may be nearing the top of this cycle. What's interesting this time around is that retail investors aren't buying mutual funds in the way they have in past cycles, they are buying ETF's, exchange traded funds. Personally I like ETF's, especially low cost ETF Index funds. Would I buy them now, at current prices, YES! Emphatically yes. What's more important is I think you should not sell. When a recession hits have some cash available in your account to buy more quality, low cost index funds, DO NOT SELL. I think all investors should have a foundation of 50%-60% of there investments in an allocation of index funds that provide exposure to all markets, not just the S&P 500. These index funds should be bought in small increments over time to average your investment. And when the market does go down, significantly, buy more because everything is on sale. The primary factor that separates retail investors who earn high rates of return and those that lose money is 'behavior'. Those that buy and sell too much inevitably lose money. Those that buy and hold, make money.

My final thoughts are, don't fear a recession, see it for the opportunity that it is. There's no guarantee that the next recession is coming next month, it might be the month after or next year or the year after that. If you own stocks look at taking a little bit off the table, nobody ever got hurt taking a profit; but leave the cash in your brokerage account so you're prepared to be a smart buyer instead of a scared seller.