With the May jobs report showing a surprisingly resilient labor market (339,000 jobs added compared to the 190,000 expected) many of you may be sick of hearing the “R” word — a recession has been threatening for so long, it’s starting to feel a little like a soap opera, where the big event we’ve all been nervously waiting for is always after the next commercial.
Yes, it’s possible that all the recession talk may come to naught. It’s also possible that one will happen and it will be very mild, or one may happen and (shocker) actually be good for the markets. That’s what Michael Yoshikami, founder and CEO of Destination Wealth Management, said on CNBC’s “Squawk Box”. Specifically, his thinking is that a recession in the U.S. may actually prevent a big market drop in the second half of this year.
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“This is going to sound crazy, but if we don’t go into slower economic growth in the United States and maybe even a shallow recession, that might be actually considered a negative,” Yoshikami told CNBC.
Crazy? Maybe not.
First, let’s clarify that absolutely no one wants a recession. Recessions negatively impact families, the mortality rate, and so much more. But if we look only at what a recession does for the markets, a little slowdown — which gets the Fed to ease up on rate hikes — might be beneficial to bond prices and certain stocks. Certainly, a continuation of rate hikes (even if we need them to tame inflation) is going to be bad.
READ MORE: 4 Investments To Avoid During A Recession
“A recession would boost bond prices as investors clamor for a safe-haven, but would undercut stock prices,” says Greg McBride, Chief Financial Analyst at Bankrate.com. “A shrinking economy reduces corporate earnings, pulling stock prices down. Of course, if you have a long-time horizon, putting money into stocks during a recession has paid off handsomely years down the road.”
“It’s fairly straightforward,” echoes Michael Halpern, president of Westmore Capital Advisors. “A recession means the economy is slowing down.” If there’s also a corresponding drop in interest rates, that will allow companies to borrow money cheaper and bring costs under control because they won’t be paying as much for goods and services because of the lower inflation. So as long as the recession doesn’t too badly impact the purchasing power of people to buy their products, their profits could improve, especially if the companies don’t also lower their own prices.
Which Stocks May Benefit
Should there be a brief recession, Halpern says, we can expect less-cyclical businesses to do better. “Tech companies — the high-quality ones that seemingly are utilities — like Google, Amazon, Apple, and Microsoft will do better when the economy slows down just because their earnings growth is more persistent.”
Also, consumer staple stocks and healthcare stocks are typically impacted less by economic slowdowns, Halpern explains. This is because no matter what’s going on in the economy, people will prioritize their health and their basic needs over almost everything else. In other words, food, toiletries, and doctor visits > new shoes, home entertainment, and pretty much everything else in the “wants” category of our budgets.
READ MORE: The Best Recession Moves Women Need To Make With Their Money
Another longtime financial industry professional, who spoke to HerMoney on background, explains Yoshikami’s theory a little differently: Since the stock market looks to the future — specifically future earnings — lower interest rates brought about by a mild recession would give companies a discount rate on the future. “When the discount rate was very low,” he says, “they used that money to capitalize earnings 10, 20, 30 years down the road. As rates went up, the value of those earnings got reduced a lot.”
Think of it this way: When you make a purchase on a credit card, and don’t pay it off that month, the cost of that purchase is lower for you when the credit card interest rates are low than when the interest rates are high. But for a company, they’re often borrowing money to build a factory or an office complex that’s going to break ground in, say, three years, and take two more to build. Which means they’ll be paying their bills off over years, not months. Therefore, every ¼ point hike of interest makes their construction that much more expensive, which reduces the company’s future profits. That’s why the stock market loves low interest rates. The flipside, however, is we get inflation — and your savings account pays bupkis.
READ MORE: Navigating Your Financial Plan During A Recession
“Stocks like Amazon and Netflix, that were trading at very high multiples of current earnings, saw their future earnings become less valuable. It’s a lot cheaper to buy a one-year Treasury that’s paying 5% than a company trading at 40 PE,” our source says. “So, unless earnings are growing very, very fast you’re not going to get that comparable valuation. A small recession will lower the discount rate and make future earnings more valuable.”
Read More:
- 10 Investing Questions Answered in Plain English
- This May Be the Only Mutual Fund You Need To Own
- 5 Ways to Buy Stocks for Kids
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