This article was coproduced with Dividend Sensei.
In recent weeks, we’ve had some exceptional economic data, and the stock market has certainly been reacting bullishly to the news.
In fact, we just had our best weekly rally in almost a year, with stocks soaring 6%, REITs soaring 9%, and some individual stocks posting double-digit gains.
What’s behind the sudden optimism? Let’s take a look at the actual data, what it means for recession risk, and what the earnings outlook looks for 2024.
Boom Times! Kind Of
On October 26th, the first estimates for Q3 GDP came in at 4.9%, well above 4.5% expectations and the strongest growth rate in 3 years.
We also had a recent productivity report come in at 4.7%, truly spectacular numbers that, if maintained, would mean almost 5% annual inflation-adjusted wage growth for workers and GDP growth of 5% sustained long-term.
For stocks that would mean almost 20% annual earnings growth, according to Bank of America, and 20% annual returns for stocks that would be on par with the 1950s, the single best decade in US market history.
Don’t Get Too Excited By A Few Outlier Figures
Productivity is measured by GDP/hours worked, so the big spike in Q3 GDP (which might be revised down in the coming 2 months) explains a lot of that.
Another reason for the productivity spike is that the big binge of new hires in recent years is finally hitting their stride in terms of productivity.
- studies show the first year of work productivity is poor
- it takes 1 year to learn your job well
About 2% of the GDP growth recorded was from inventories rebounding from the previous two quarters when they showed -2% growth.
What is happening here?
Most likely it’s a rebound from the Pandemic which really messed with supply chains for durable goods.
Remember that in the lockdowns everyone got checks ($4 trillion in stimulus) and couldn’t go out and spend it. They had to buy physical stuff which is why companies like Target spent over a year rushing to buy as much inventory as possible.
Amazon doubled its logistics network in 2 years to deliver the flood of new demand, and chips companies reported double or even triple ordering.
- companies like GM were ordering 3X as many chips as they actually needed from 3 different companies on the hopes that they would get at least 100% of their actual needs filled
After the big flood of demand was fulfilled, the economy reopened with vaccines and ended the Pandemic. Revenge travel took off, Taylor Swift’s concert tour grossed over $1 billion ($4 billion economic impact), and Pink tickets sold for $4,000 to $9,000 for some seats.
Suddenly companies like Target went from not having enough to sell to having way too much…of the wrong kind of stuff too!
For context, Target’s earnings went from parabolic growth to a 56% crash in a single year. In the Great Recession they only fell 14%. This is how bad the inventory glut was.
Clorox soared 65% during the Pandemic as Americans tried to protect their loved ones by drowning them in Purell hand sanitizer;)
And then, when that one-time demand vanished, earnings fell by 44% in a single year, 5.5X more than the previous record earnings decline.
Shipping costs skyrocketing 500% in a year is yet another example of the supply chain hell we all went through.
So what did corporate America do? Almost 2 years of negative inventory order growth as businesses stopped ordering new things when Americans were heck-bent on going to see Barbenheimer and Taylor Swift (and Pink, it seems).
In the last year or so, concert tickets roughly doubled to $120 each.
In other words, the Pandemic created a massive imbalance in the service economy (66% of the US economy), and the extreme fluctuations in supply and demand are still reverberating through the economy like a gong being slammed with a hammer.
Companies, after 18 months of ordering nothing for inventory, had to stock up before Christmas, and so we had a massive spike in inventory demand of 2%.
Here’s What Economists Expect Now
The Bloomberg economist consensus now expects no recession, not even a single quarter of negative growth. They just expect very weak growth as the Fed’s 7% in effective hikes takes effect.
But by the end of 2024, they expect the economy to recover to its long-term trend growth rate of 2%.
The Bond Market Says Economists Are Still Wrong
Campbell Harvey thinks that the Fed’s 7% worth of hikes (including QT) will eventually trigger a mild recession in 2024.
But wait a second, haven’t we all been lied to by the yield curve? For over a year, economists have expected a recession, and instead, we have the strongest growth in 83 years.
Best Economic Expansion Since 1960…So Why Is Everyone So Miserable?
I bet you didn’t know the economy, adjusted for inflation was growing at the fastest rate since 1960.
So why is everyone so upset?
Depending on what you have to buy, your life might be miserable.
Consider home prices which are up 40% in the last 3 years, almost 3X more than wages.
The highest mortgage rates in 23 years combined with the highest home prices ever have caused the median mortgage to rise 4X in the last decade.
Guess what that does to people’s ability to buy homes? If your American dream is owning a home then for many Americans that dream is dead.
10 years ago, Americans earning $55K could afford to buy the average home. That was the median household income. Today it takes $115K of household income to afford the average home.
The only ones who can afford to buy a home, statistically speaking, are those with college degrees and just barely.
And don’t forget how inflation works.
The price increases are not going away. If prices rise by 40% in 3 years and then grow at 2% per year forever, the Fed calls that victory.
For the 150 million Millennials and Gen Z looking to start families and buy homes? Well, they are just pure out of luck.
Depending on what you need to buy, your personal inflation rate might be a lot higher than the Fed’s official estimates.
The Fed’s official inflation metric Core PCE is currently 3.6%, and the Cleveland Fed thinks it will remain at 3.6% until the end of the year.
That’s almost 2X the Fed’s 2% target and you can see why the Fed claims it will keep rates at 5.25% (current lower bound) until November 2024.
The bond market believes there is a 98% chance the recession will start by October 2024 which is 2 years after the yield curve inverted.
The average time from yield curve inversion to recession start is 2 years, or October 2024.
The bond market was never saying recession in 2023, that was economists, who famously have never once predicted a recession ahead of time.
The bond market? Since 1953 it’s never been wrong about recession.
So is this time different?
38 Trillion Reasons The Recession SEEMS To Be Taking So Long (It’s Still Right On Schedule According To The Bond Market)
Remember how the government sent everyone 3 checks (well most people) and did $5 trillion in stimulus and the Fed printed $4 trillion?
That $9 trillion in stimulus resulted in the value of stocks and other assets soaring $38 trillion.
Americans became $38 trillion richer and here’s how much economists think that translates into extra spending.
So far consumers have spent $800 billion of that $1.5 trillion economists estimate we’ll eventually spend out of the Pandemic boom.
That’s only 5 months of consumer spending so what gives? Why were economists so wrong?
Because excess money doesn’t just get spent all at once. Americans love spending and that’s why our savings rate is so low.
Americans are spending their incomes and last $700 billion out of that $38 trillion in new paper assets they got from the government spraying everyone with free cash.
- inflation proves that free money isn’t actually free
The Good And Bad News About The Economy
The good news is that while the bond market is 99% certain recession is still coming next year, it’s going to be a mild one.
Financial Stress Is Below Average: Anyone Telling You Another GFC Is Imminent Is Lying
The St. Louis Fed, and Kansas City Fed both have their own financial stress indexes, which are calibrated so zero = the average level of financial stress since they began tracking data.
Negative = below-average stress, and right now, both indexes are negative.
The Chicago Fed’s financial stress index is the oldest and most advanced.
Combined St. Louis, Kansas City, and Chicago Feds are tracking 134 weekly financial indicators, providing a nearly real-time big-picture view of the economy.
If there were a financial crisis brewing it would be in this data and it’s not.
So What’s Up With The Economy Now?
The Atlanta Fed’s model has nailed the last two quarters of growth and currently estimates 1.2% growth right now.
NY Fed estimates 2.4% growth right now though the range of potential growth rates is as low as 0.86% and as high as 4.13%.
For 18 straight months, the Conference Board’s leading indicators have been negative.
That’s the 2nd longest streak; the longest was 24 months before the Great Recession.
- that doesn’t mean a crisis is likely; it just means that the Fed can take as long as 4 years to cause a recession through higher rates
So What About Earnings? And The Stock Market
Weekly Decline In S&P EPS Consensus | Last Week’s EPS Consensus | Year | EPS Consensus | YOY Growth | Forward PE |
0.00% | $206.04 | 2021 | $206.04 | 50.03% | 20.6 |
-0.07% | $215.66 | 2022 | $215.50 | 4.59% | 19.7 |
0.00% | $219.05 | 2023 | $219.06 | 1.65% | 19.3 |
-0.04% | $245.22 | 2024 | $245.12 | 11.90% | 17.3 |
-0.13% | $274.20 | 2025 | $273.84 | 11.72% | 15.5 |
Recession-Adjusted Forward PE | Historical 2024 EPS (Including Recession) | 12-Month forward EPS | 12-Month Forward PE | Historical Overvaluation | PEG |
19.87 | $213.25 | $241.11 | 17.576 | 4.43% | 2.07 |
Historically Overvalued | |||||
17.6% |
(Source: Dividend Kings S&P 500 Valuation Tool, FactSet)
The market is back to modestly overvalued, assuming no recession next year and 12% growth in 2024 and 2025.
If there is a recession and earnings fall the historical 13%? Then stocks are currently 20X earnings or almost 20% overvalued.
S&P Bear Market Bottom Scenarios Recession Starts At Any Time In 2024
Earnings Decline | S&P Trough Earnings | Historical Trough PE Of 14 (13 to 15 range) | Decline From Current Level |
Peak Decline From Record Highs |
0% | 274 | 3834 | 9.5% | -20.4% |
5% (Consensus) | 260 | 3642 | 14.1% | -24.4% |
10% Goldman Sachs | 246 | 3450 | 18.6% | -28.4% |
13% (Avg since WWII) | 238 | 3335 | 21.3% | -30.8% |
15% | 233 | 3259 | 23.1% | -32.4% |
20% Moody’s, Morgan Stanley | 219 | 3067 | 27.6% | -36.4% |
25% | 205 | 2875 | 32.2% | -40.3% |
30% | 192 | 2684 | 36.7% | -44.3% |
35% | 178 | 2492 | 41.2% | -48.3% |
40% | 164 | 2300 | 45.7% | -52.3% |
45% | 151 | 2109 | 50.2% | -56.2% |
50% | 137 | 1917 | 54.8% | -60.2% |
(Source: Dividend Kings S&P 500 Valuation Tool, FactSet, Bloomberg)
If earnings in 2025 are 13% below current expectations due to the recession, then the historical base-case for stocks is a 21% decline from here and a 31% peak bear market bottom.
- -28% is the current base-case
At the moment the worst-case scenario is from Morgan Stanley and Moody’s expecting a 36% peak decline for stocks in the event of recession next year
Time Frame | Historically Average Bear Market Bottom |
Non-Recessionary Bear Markets Since 1965 | -21% (Achieved May 20th) |
Median Recessionary Bear Market Since WWII |
-24% (Citigroup base case with a mild recession) June 16th |
Non-Recessionary Bear Markets Since 1928 |
-26% (Goldman Sachs base case with a mild recession) |
Average Bear Markets Since WWII | -30% (Morgan Stanely base case) |
Recessionary Bear Markets Since 1965 |
-36% (Bank of America recessionary base case) |
All 140 Bear Markets Since 1792 | -37% |
Average Recessionary Bear Market Since 1928 |
-40% (Deutsche Bank, Bridgewater, SocGen Severe Recessionary base case, Morgan Stanley Recessionary Base Case) |
(Sources: Ben Carlson, Bank of America, Oxford Economics, Goldman Sachs) |
Guess what you call a 36% bear market decline? Completely historically average.
Why We Don’t Just Sell All Our Stocks And Hide In Cash
If you could perfectly predict every single recession of the last 90 years you would have only beaten the market during the Great Depression.
Outside of the worst economic collapse in history, perfect economic timing doesn’t cause better stock returns.
The average peak market decline since 1928 is 16%.
In any given year you should expect stocks to fall 16%. That’s normal.
Every four years you should expect stocks to fall 20% or more, into a bear market.
That frequency held true in the era of free money and since WWII. Interest rates don’t stop bear markets even if they are at zero.
Over the last 20 years or so the average investor earned 38% after inflation while the S&P went up 207%.
That’s all because of market timing.
There are always scary headlines, you have to trust your companies and good risk management in your portfolio.
If you try to avoid bear markets, you’ll miss the 10 best single days of each decade. And that means a -94% inflation-adjusted returns in stocks since 1930.
- the worst market decline in history was -87% during the Great Depression
The only way the doomsday prophets will ever be right and you risk a 90% decline in your portfolio is if you listen to them and try to time the market.
Look What Perfect Timing Gets You
Perfectly timing the market gets you all of 22% better returns over 50 years.
That’s 0.2% higher annual returns in exchange for risking losing everything.
160 years of data shows that 70% of the time you are better off buying immediately, not even dollar-cost-averaging over several months.
That’s because the stock market goes up in 76% of years.
In fact, investing 100% of your savings into stocks compared to dollar-cost averaging averages 104% higher inflation-adjusted returns every 30 years.
That’s double your returns over 30 years and over an entire investing lifetime including retirement about 300% higher real returns.
- your neighbor uses DCA starting at age 20
- you invest all your money at age 20 and keep doing it
- at age 80 you have 4X more inflation-adjusted wealth than your neighbor
He retires in comfort on a $1 million nest egg, and you have $4 million, retiring in safety and splendor.
Bottom Line: A Recession Is Very Likely In 2024, But That Shouldn’t Change Your Long-Term Plans One Bit
The last two recessions were historic, and so a lot of people assume every recession is horrific with a crashing market, and millions of job losses.
In fact, the coming recession is likely to be mild, possibly the mildest in history.
To avoid the stock market out of fear of recessions is like avoiding Florida at all times because it occasionally has hurricanes.
Florida is a wonderful place to live or visit, and America’s world-beater companies are the best way to retire rich and stay rich in retirement.
We watch Bloomberg (and C-Span) so you don’t have to.
Life is too short to obsess over the economy, and that’s why we help you build sleep-well-at-night portfolios that can be trusted to handle anything DC, the Fed, the economy, or the stock market throw at us in the coming years and decades.
Note: Brad Thomas is a Wall Street writer, which means he’s not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.