Are We Out of the Woods Yet?

There's always a bigger, badder wolf.

Are we in a recession? Headed for one soon? If so, will it be deep? Such has been the growing talk for the past few weeks. My feel for client and man-on-the-street sentiment is that recession is here or coming for sure.

FWIW, the Bureau of Economic Analysis (BEA) reported today that the U.S. economy experienced a slight contraction for the second straight quarter. This is a technical measure of recession, but it is up to the National Bureau of Economic Research (NBER) to eventually determine it officially. They rely on the importantly more vague definition of a significant period of economic downturn.

Many economists will insist that we can’t really have a recession without a significant increase in unemployment, which we haven’t seen in this cycle . . . yet.

I think we are likely not yet in a recession, but I think the risk is quite elevated that we will enter one soon. I would put some degree of recession within the next 12 months at about 65% likelihood.

For investors the question is often posed as “are we out of the woods yet?” To which I answer in not so few or direct words: “I don’t know, it is not really knowable, and it is likely a meaningless question.” The truth is there is always another woods yet to come.

People don’t like this answer, but it is the truth. There isn’t an “all clear” that we get as investors. In fact we don’t want that from the standpoint that the surer and safer conditions appear, the more likely it is that large, hidden risks are present. Besides, surer and safer would mean expected returns—the compensation for taking risk—would be quite low.

Only in hindsight is a period “in the woods” mistakenly evident. We forget how treacherous the landscape appeared following the worst of a bad market period. We overlook how many mistakes are made investing during periods when it seems looking back to have been easy.

We are always in some woods, working our way through them, on our way to other woods that will be similar enough to seem passable and different enough to scare us. In one sense it is always a “new normal”. In another we are constantly fighting the same dragons of risk: inflation, deep drawdown, overreaction, poor timing, etc.

Great investing relies not on deft timing, masterful swapping among asset class selections, and big bets in and out of riskiness so as to conquer the wilderness of a given economic environment. We likely cannot know the forest for the trees. Great investing is about survival and perseverance. It is knowing we are in the woods to stay, and our tools are prudent risk taking, diversification, and the discipline to both stick with a plan as well as adapt it as the journey progresses. All of these are arts more than sciences.

The only thing more ominous for investors than the illusion that we’ve been here before—hence, we have the map for safe navigation—is the dangerous assumption that this time is different—hence, we can’t possibly use previously successful strategies.