With all of the negative macro events going on, from the Ukrainian invasion to the COVID pandemic and its ripple effect on global supply chains and elevated inflation, it’s remarkable that the stock market has held its own so well. With the Nasdaq 100 looking to fully recover from the move into bear market territory, investors ponder what comes next, with the U.S. yield curve now inverted. The last time the yield curve inverted was back in 2019, and the 2020 recession struck on the back of the COVID-19 pandemic.
Would the recession still have happened if there was no pandemic? It’s hard to tell; regardless, it’s hard for many investors to ignore to the predictive power of such an economic indicator that’s proven so accurate in the past.
Now, the yield curve inversion is no crystal ball. It’s not 100% accurate. It can be wrong, especially given moves made by the U.S. Federal Reserve. With rate hikes and the prior purchase of longer-dated bonds, a yield curve inversion is something that’s just waiting to happen. Still, with all of the macro question marks going on right now, another recession should come as no surprise. Unfortunately, if a recession does hit the global economy, it could be the second within a three-year timespan.
Should you treat last week’s inversion as an alarm bell?
Probably not. Recessions don’t have to mean irrecoverable losses for investors. Remember, central banks have no desire to induce economic damage. They merely want to cool inflation. In theory, it can be cooled without dragging the economy into a 1970s-like economic downturn. With the Fed so focused on engineering some sort of so-called soft landing, I think investors should invest cautiously and focus on time in markets, rather than looking to time the markets by entering and exiting based on indicators that many are fully aware of!
Even if you decide to ditch stocks, inflation will eat at the value of your cash. So, like the Fed, you’ve got to find the optimal balance between risk and safety. With the yield curve flattening for many months, an inversion should come as no surprise. And while the ominous indicator is scary, there may be nothing to fear other than (wait for it!) fear itself, as the old saying goes.
Stay prudent. Take risks only when the rewards potential make sense
Should you take a bit of risk off and invest in value amid the rotation out of growth?
I’d argue that would be prudent. But I’d not ditch growth for the sake of lightening up on growth. Profitable growth and dividend growth are still vital for long-term outperformance. Personally, I think staying the course, perhaps with more focus on getting the most out of every dollar invested, is the best course of action. Don’t overreact and hit that sell button furiously next week, even though others may fear a hard-landing recession, as the Fed looks to hike further.
After a turbulent week, I’d look to CN Rail (TSX: CNR)(NYSE: CNI) as just one of many intriguing plays to buy. The stock spilled nearly 5% to end last week as a part of a broader industry-wide selloff. Indeed, transports tend to feel pain when economic conditions weaken.
That said, CN and its peers are among the most durable of firms with the widest moats out there! They’ll take a hit on the chin if we are headed for another recession. But they’ll be so quick to get back on their feet that any stock price pain is likely to be short-lived versus most other economically sensitive stocks on the TSX.
Dividend and earnings growth are where it’s at!
Last week’s dip, I think, is an opportunity to buy as others sell in the face of another recession. As to whether the next economic contraction drags us into another bear market is another question. It could, but investors are better off not trying to figure out when to sell or when to buy.
Like it or not, a recession may not strike when you expect it to, and the gains between now and the start of the next recession could have the potential to be sizeable. Understand that the stakes are higher, but there are still gains to be had if things aren’t nearly as ugly as they seem. For now, I prefer dividend and earnings growth over sales growth. They’re the new class of growth stocks that could thrive in today’s rocky road of a market.
