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Recession on the Horizon?

After falling 20% from January to mid-June, the S&P 500 stock index rallied over 17% by August 16. On that day, a new federal stimulus bill including a minimum corporate tax and a tax on stock buybacks was signed into law, and the market again began to decline. The downturn was further spurred by Fed Chairman Jerome Powell’s speech in Jackson Hole, WY, last week, when he again reiterated that the central bank must keep raising interest rates and then hold them at high levels to fight inflation, even if it hurts economic growth.

With the Fed raising short term rates, the Treasury yield curve has become slightly inverted (short term rates are higher than longer term rates) with the 2-year Treasury yielding 3.50% and the 10-year treasury yielding 3.25%. Historically, an inverted yield curve is a signal of pending recession. However, the labor market remains very strong. The Labor Department reported that there were 11.2 million unfilled U.S. job openings at the end of July. That comes to two openings for each person counted as unemployed during the month.

Shaded areas are recessions. Source: Crandall Pierce

The stock market is a leading indicator of the economy. It turns down well before the economy falters, and it bottoms and begins to rise well before the economy recovers. Stocks have fallen a median of 24% in recessions since World War II. As noted above, the S&P 500 index fell 20% earlier this year. The median return one-year after the market troughs is 39% and the median return after two years is 58%.

While the S&P 500 stock index has historically not fared well during periods of recession, one group of stocks has performed very well. Those are the so-called Dividend Aristocrats – companies that have raised their dividends for at least 25 consecutive years. That group has a median return of 12.7% in past recessions.

We continue to focus on companies with strong balance sheets that generate a growing stream of free cash flow and return a portion of that cash flow to the shareholders in the form of steadily rising dividends. Investing in companies with growing earnings and dividend streams has proven to be one of the best protections against inflation.

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