“The stock market has predicted 9 of the last 5 recessions” - Paul Samuelson
This quote from a Nobel prize winning economist pokes fun at the inherent inaccuracy of the stock market’s ability to be a useful predictor of recessions. The stock market is known as a leading indicator, meaning it gives us clues to where the economy might be heading. Regardless of its accuracy as a tool for predicting the future, a decline in the stock market for extended periods can cloud our judgment, and can make us act more conservatively because we think we are going into a recession. This collective action could become a self-fulfilling prophecy that otherwise could have been avoided if we had not all experienced a declining market.
Adding to the collective fear of a recession, some of the country’s largest and most influential companies have shared negative news about the coming months.
Target said it would embark on a program of “additional markdowns, removing excess inventory and canceling orders” from suppliers. They revised their profit estimate by half from what they predicted just one month ago. This might be good for a deal on a TV, but is unlikely to reduce the cost of common household consumables.
JP Morgan’s CEO Jamie Diamond, said that investors should brace themselves for an economic hurricane, and that they are going to be very conservative with their balance sheet. Banks make money by issuing loans, and this means it will be harder for businesses to access those loans, which slows economic activity.
Amazon said in May that they overstaffed their warehouses due to demand being weaker than forecasted only a few months ago. This will lead to layoffs, which means workers will be more willing to accept lower pay, which again slows down the economy.
This slow drip of negative consensus has the power to convert even optimistic CEO’s to think more conservatively. Looking at the US economy as a whole, it would be impossible to measure the results of one company tightening its financial belt. When hundreds of companies act conservatively in unison, especially those in the technology and consumer discretionary sectors, economic activity could slow down for some time, which is the definition of a recession.
A critical point to stress again is that the stock market is a leading indicator, meaning when we start getting signs that economic activity is anticipated to improve in the near future, the stock market is likely to rise. Because nobody knows how long the economic slowdown will last, we believe it is important to stay at least partially invested during these uncertain times. Our greater than normal cash position is remaining more or less unchanged. We are eager to get it back into the markets, however we are remaining patient at this point in time.
As always, if you have any questions please do not hesitate to give us a call.
Citrus Wealth Management
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