The term “recession” has been tossed around a lot lately. In general terms it seems to represent a scary situation when it comes to the economy and our financial future. But what does it really mean? From an investment standpoint we may have already seen the worst.
Investopedia defines recession as a “significant decline in economic activity that goes on for more than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country’s gross domestic product (GDP), although the National Bureau of Economic Research (NBER) does not necessarily need to see this occur to call a recession.”
An economic recession is typically characterized by two consecutive quarters of decline in gross domestic product (GDP). GDP growth has been very strong the past three years. On December 21, 2018, Kiplinger reported estimated GDP growth of 2.8% for fourth quarter 2018. It is possible we could see a significant decline in 2019; however, current estimates are for 2.6% annual GDP growth. I believe it will take a significant decline in employment levels and increase in inflation to see this occur. This technical indicator is more likely possible in 2020, or beyond.
An earnings recession is characterized by two consecutive quarters of negative earnings growth. There may be some valid concerns regarding a decline in earnings for 2019. Apple Inc. recently reported an estimated slowdown in sales growth for the fourth quarter for 2019, which may be lower than sales in fourth quarter 2018. This would mark the first holiday slowdown since Cook became CEO in 2011. How this will translate into earnings is yet to be known.
FactSet estimates 2018 earnings growth to be 20.3% versus 2017. Much of this increase is due to the favorable corporate tax rules that came into play in 2018. 2017 earnings growth came in at 11.4% versus 2016. 2019 growth may be very difficult following two strong years.
Investment returns rely on two primary factors—corporate earnings and the relative price of stocks. FactSet publishes an interesting chart on a regular basis that compares trailing 12-month earnings per share (EPS) versus the current price of the S&P 500 index. This gives us a visual idea of how prices compare to earnings.
Price of the S&P 500 index is in light blue on the chart below, while trailing 12-month EPS is represented in dark blue. Prices were quite a bit ahead of earnings levels throughout 2016 and 2017.The fourth quarter decline in price level has almost brought the two measurements in line with one another.
Despite threats of recession, this indicator shows limited downside risk to current stock prices. This is no guarantee that stocks can’t decline further, especially if we see an earnings recession in 2019. Keep in mind the stock market is typically a leading indicator of recession. Recessions are not fun, and we may be seeing the start of an earnings and/or economic recession. It may be a year or more before we see the nice price gains we have seen over the past 10 years. However, from an investment perspective, maybe we have experienced much of the market recession pain. Don’t let the cry of “recession” scare you from investing.