Second Half Regime Change

When the Fed wrapped up its most recent meeting they announced another quarter point interest rate hike and the markets barely blinked. Markets have been on a tear and the rate rise did not deter them. Also, the tone coming from the Fed was much more accommodative than it has been over the last year. A lot has changed in that timeframe even since just six months ago when recession fears were peaking and major stocks like Google and Facebook were in freefall. Fed chairman Powell stated they would be “data dependent” regarding whether to raise rates again.

Over the past year and a half, the Fed has been at war with inflation. Raising interest rates has been their key weapon. The war is now essentially over as the current inflation rate is 2.97%, compared to 4.05% last month and 9.06% last year. Nevertheless, the Fed does not want to take their foot off the brakes just yet and cause inflation to pick up speed again. Also, the economy is showing that it is healthy enough to withstand higher rates for longer. Lending has picked up relative to a month ago, commodity prices are higher, and home prices are ticking up. It’s likely that the Fed won’t ease up on rates until these prices fall and job losses mount.

An economy with steadying or even decreasing rates should be good for stocks, but this new normal might be already priced into the larger players. In the second half of last year almost every sector of the market was already on an uptrend except for large-cap growth (AAPL, GOOG, MSFT, META, etc). Then in January we got a regime change and money rotated into these mega companies and out of most everything else. Many of these stocks made huge gains, but now it may be time for another regime change where a different sector or market cap (company size) takes the lead. The Nasdaq and S&P are both pushing up against the recent highs of last October where they ran into resistance and then fell until January. If technology is not participating in the upside during the second half of this year, then the overall markets are going to have a tough time as well. This does not mean there is no money to be made in this market, however. Industrials are already making new all-time highs, and we are seeing strength in the small and mid-cap space as well, as companies with market capitalizations below $10 billion play catch-up.

From a purely valuation perspective, stocks still look more attractive than bonds and non-tech stocks (like industrials, banks, and energy) look undervalued relative to their technology counterparts. At the end of the day, it’s all going to come down to the dollar. If the dollar is still falling in value, then stocks have room to run higher. And a more accommodative Fed should keep this trend on track. A cheaper dollar means higher profits for US multinational companies as they have pricing power over competitors. Over the next several months which regime will reign supreme? Tech has strong tailwinds, but we are keeping a watchful eye on other pockets of value.

Sector Rotation

 Investors are hearing a lot right now about how weak the overall market is. Pundits are saying that only a few stocks are carrying the indices higher and that if you look more broadly, stocks are in a bear market. But this simply is not the case. What’s actually going on is classic sector rotation. In the second half of last year (after a horrific first 6 months), all sectors other than tech started advancing. Oil and gas companies had banner years, banks did well, and so did consumer staples and industrials. As interest rates rose through 2022, companies that relied on lots of cash to fuel growth and operations suffered greatly. Then two powerful forces came together and changed their fate. Inflation began to ease (bringing interest rates with it) and the AI revolution kicked off. Growth stocks surged as money flowed back into the technology space and out of defensive, low volatility stocks. So when analysts look at the markets this year, they see a narrow area of performance and remain overly pessimistic. But this is not a market breadth thing, it’s just a rotation thing. Conversely, when tech underperforms, the broader market outperforms on a relative basis. However, this does not mean there is more market participation or that the markets or economy are healthier. When Apple and Google do well, of course the indices are going to be lifted even if other companies aren’t advancing as much. It’s just like in sports, your best players are supposed to score the most points and carry the team. And the best players in the economy right now are mega-cap growth companies.

Within the growth and technology space some trends are emerging. Semiconductors are leading with Nvidia becoming the first chipmaker to reach a trillion-dollar valuation. Apple is near its all-time high as it too makes chips and time spent on mobile devices per day has gone from 25 minutes in 2010 to over 4.5 hours today. Software stocks are also at 52-week highs (still down from their COVID peak) led by Microsoft, Salesforce, and Adobe. And any company that is AI adjacent is getting a huge pop.

There is a chance that AI will be as large a force and shape our lives as much as the internet did in the late 90s. If this is the case, then we are at the very early stages of this economic shift. The bulk of the market moves to come will likely feel like “irrational exuberance,” as Alan Greenspan put it during the dot com bubble. There will also be some quick and nasty pullbacks in AI and tech along the way. But pullbacks rarely come when people expect them. Look at Nvidia. It had nearly doubled year-to-date heading into earnings. Many trades opened short positions, betting against the stock thinking it was overvalued. Then the earnings were announced (which were stellar) and the stock jumped 30% - the largest post-earnings gap for a mega-cap stock ever, adding over $200 billion in market cap in a single day. The dips will come when everyone is on the AI and tech train and bought into the story. And the dip will be so brutal investors will question the narrative. This will be another good entry point for the sector.

Note on Interest Rates and Earnings

Many have inquired about interest rates and what that may mean for them and the markets. On Wednesday, the Federal Reserve raised the federal funds rate by an additional 0.25%, the 10th time it has done so in just over a year. This is the fastest pace of interest rate hikes in history and is leading to increased borrowing costs everywhere. Credit card rates have reached an all-time high of over 20%, home equity lines of credit are averaging 8%, and 30-year mortgages are around 7%. We expect this to be the last increase for some time as the higher rates lead to decreased economic activity and lower inflation. The entire goal of the rate increases is to lower inflation, and all indications are that it’s working. The good news is that interest rates on savings and money market accounts are dramatically better than they were a year ago. The average money market yield is over 4%, offering an alternative to bonds and dividend paying stocks for conservative investors.

While we are seeing decreased lending and GDP growth, companies themselves are still making money. The banking sector has been under pressure as a result of these rapid rate increases as evidenced by the Silicon Valley Bank collapse, First Republic, and now possibly PacWest Bancorp. But broadly speaking the economy has been resilient and fully 70% of companies reporting earnings are beating estimates and giving positive guidance. Yesterday, market bellwether Apple reported better-than-expected numbers on earnings per share, revenue, and profit margin – bringing in over $94 billion dollars in the first quarter. Having patience and investing in quality assets is a good way to weather these interest rate cycles.

The Rise of AI

The financial markets have been under siege since the Fed started raising rates over a year ago. During much of that time investor sentiment has been poor with little reason for optimism. As we have previously discussed here, growth stocks are getting beaten up the most with the fear being that their reliance on cheap loans to fuel growth is unsustainable in a rising interest rate environment. Meanwhile, industrial and oil companies have been the darlings even as consumers and countries alike transition toward new technologies and more sustainable energy solutions. But this past December attention was once again turned to tech as Silicon Valley and San Francisco unveiled Chat GPT-3, an artificial intelligence large language model, or LLM. The titans of tech stood up and took notice. We are already familiar with aspects of language models and chat bots. Think of Siri or Google Home. But this one is much more robust and offers far greater computing power. Alphabet (Google’s parent company) sent out an internal memo and held an emergency meeting after the release and Microsoft went a step further and bought a $10 billion chunk of the company behind the new technology.

It remains to be seen what applications will spring forth from this new AI, but anyone who has played with it can see the potential. Tech stocks have broadly rallied on the renewed optimism of AI and hopes that the Fed may be nearing the finish line of their rate hiking campaign. Technological advances often put downward pressure on inflation, which the Fed is currently fighting. But what’s good for consumers might be bad for the incumbent companies. It appears Google might have the most to lose since at its most basic level Chat GPT offers direct answers to questions rather than pointing one to sources that may have the answer (as Google search does). It can also provide these answers in creative ways if you ask for it. For example, I asked it to write me a poem about the basic rules of investing. Here is a portion of what it created:

Here are some basics that’ll help you invest, and make sure you do your best.

First, diversify your assets, don’t put all your eggs in one basket,

spread your investments across different classes, so that losses in one won’t hurt your masses.

The real breakthrough is that this tool can do work. The above is an example of it working to make a simple poem, but it can work to organize your spreadsheets, do very complex math problems, write essays, and even code. The productivity increases in some industries could be staggering. What used to take teams of computer scientists dozens of hours can now be done in minutes. The major breakthrough applications probably have not even been thought of yet. Just as the invention of GPS (completed in 1995) would lead to the creation of Uber and dismantle the taxi industry some 20 years later.

As the saying goes, “there is no free lunch,” so enhancements in one area will likely cause destruction in other areas. Whichever jobs are made obsolete, it is my hope that new and better opportunities will arise to fill those spaces. In a time of high inflation and the uncertainty of war, a new technology that is fun to use and will drive down costs is most welcome.

Instant Feedback and Long-term Goals

January brought a much-needed bounce to stock portfolios, rising about 5% on the S&P 500 and around 10% for the tech-heavy Nasdaq. Major indices finished 2022 down around 20% with many stocks experiencing much deeper declines as investors grew more and more bearish. So, as prices began recovering to start the year some stocks soared dramatically when traders who shorted them rushed in as buyers to cover their position. Economically, not much had changed over the past 30 days, and yet this price action was all too normal for investing and for human behavior. Since stocks prices are set by traders’ future expectations this inherently leads to speculation and volatility. As we can all attest, humans are by and large impatient. We also have inherent biases that guide our actions. We might think we have a great idea, one that we put lots of time, effort, and thought into and then quickly abandon if it doesn’t immediately yield results. We are fickle and quick to extrapolate what we have just seen into long trends. Unfortunately, these deeply ingrained instincts can get in the way of our long-term planning and goals. The instant feedback loop of the stock market is hardly useful except to a small minority of traders with the skill to capitalize on the price action and consistently win. Every price movement can feel like a compliment or criticism of our decisions, clouding our judgment and resolve going forward.

As long-term investors, the daily price quotes that provide instant gratification or humiliation are actually of little value and have almost nothing to do with the long-term quality of our decisions. It is possible to make terrible decisions that result in terrific short-term returns and vice versa. There is no perfect method to combat the harm of instant information from the financial markets. Value investors who internalized the teachings of Benjamin Graham and Warren Buffett waited over a decade for their thesis to play out last year. It’s important to zoom out and remember that healthy portfolios are built to withstand and profit throughout many market cycles. Whether markets are ripping higher or slumping lower it is always best to mentally slow down and anchor to something psychologically other than daily price quotes. Trust in the process of consistently saving and investing. Don’t deviate if motivated by greed or fear. Many times, we have seen an investor or hedge fund go bankrupt because they borrowed money and chased returns on the way up and got caught overexposed on the way down or shorted a stock on the downside only to see conditions improve and the stock move higher. We may be preaching to the choir, but these tenets of investing are not well understood or rather not well internalized. Humans will always overvalue instant feedback because it was necessary for our survival evolutionarily. It is up to us to have the discipline to understand when instant feedback is useful and when it is meaningless noise distracting us from our long-term goals.

In the meantime, enjoy the returns of the past month but check yourself if you start thinking stocks only go up. Also check yourself if you are still reeling from the hangover of last year, thinking stocks are dead. Easier said than done.

2023 Forecast

The new year can’t get here soon enough. Twenty twenty-two will go down in history as one of the toughest markets ever. The famed 60/40 portfolio consisting of 60 percent stocks and 40 percent bonds had its worst year on record giving up around 19%, which is not far off from the 20% drawdown of the S&P 500. Usually, bonds offer a hedge against falling stock markets as interest rates are cut to spur demand. There were simply very few places to hide as interest rates suddenly shot up in efforts to tame soaring inflation causing both stocks and bonds to fall simultaneously.

Rising interest rates can be a powerful tool to reduce high prices by making money more expensive, jobs more scarce, and hampering demand for goods and services. The problem is that it can take months to work, so it’s difficult for the Fed to know when to stop hiking rates and how much the economy will suffer. In 2023 we believe the Fed will push rates up several more times before topping out around 6% mid-year. Hopefully, this will be just enough to slow inflation but not enough to severely damage the economy. There is a chance the Fed can pull a rabbit out of the hat and do just that, something that has not been easily accomplished during previous rate hiking cycles. The job market might be strong enough to allow this to happen. Deep recessions coincide with massive job losses, yet it’s unlikely we’ll see mass unemployment this time around as most businesses’ main complaint is the struggle to find and keep quality workers. The tight labor market is one of the reasons we are seeing such strong and persistent inflation. It’s still better than the alternative. No jobs and lower prices. Related to this is another reason to be hopeful we won’t see a bad recession in 2023. Namely, business and household balance sheets are surprisingly healthy. The US is a consumer driven economy and so far the consumers have remained resilient, continuing to buy goods and services at a brisk pace, propping up the economy. Rising wages from the tight labor market and the $2 trillion savings built up during the pandemic have greatly bolstered balance sheets and allowed for continued and increased spending.

Driven by the strong consumer and the dollar’s status as the global reserve currency, we remain optimistic for the US relative to the global markets. It is likely that Europe will fall into recession, if not already in one, and the rest of the world will see only modest GDP growth of roughly 2.5%. Tailwinds from Federal, state, and local fiscal stimulus enacted in the past two years should support US GDP growth. However, we don’t expect to see quite the same returns this coming decade as we saw during the last decade. Now that 4% can be made on cash, stocks suddenly have some competition. Interest rates will likely remain elevated for some time due to the inflationary pressures of an aging workforce and increased protectionism around the globe. As countries close borders it makes it more difficult for businesses to find cheaper labor elsewhere. Additionally, the movement and availability of goods is hindered adding to business overhead and putting upward pressure on prices. In this economic environment, businesses with established supply chains, robust market share, and reliable cash flows will likely be more desired by the investment community than their fast-growing, capital-intensive peers.

Some predictions for 2023. It is likely to be volatile (although much less so than 2022), with dividend paying stocks outperforming non-dividend payers, and domestic stocks outperforming international stocks. Corporate earnings will grow 5-10% and instead of retracting, equities will advance by year-end in the high single digits with some areas of the market seeing massive returns as investors realize fears were overblown. Energy companies will underperform relative to other sectors such as healthcare, and housing will continue to drag as mortgage rates climb, destroying purchasing power. Technology companies will remain under pressure, but we will start to see the leaders of the next decade rise from the heap. Bonds will also continue to struggle as longer-dated maturities quickly lose value with each increase in interest rate, but short-term notes and cash will offer attractive alternatives to stocks for risk-averse investors for the first time in two decades.

The Value of Value

Value is back and being talked about more than at any time in the last 15 years. The value investing strategy has been around forever but often gets overshadowed by more exciting “growth” investing. The basic premise is to invest in a stock or basket of stocks that appear cheap based on a particular metric, say earnings per share (total profit divided by total share count). The strategy was codified in 1928 by Benjamin Graham and later made more famous by Warren Buffett. All year there has been a growing drumbeat for the value sector as borrowing rates have increased and growth stocks have fallen out of favor. The darling of this sector has been energy (as discussed in previous posts), but favored names now include drug companies, banks, defense industry stocks, and some consumer staples like Walmart and Coke. Investing in boring companies and industries like these have remained a part of our core strategy (even during the high growth euphoria era) because they are stable and allow you to fight another day. Additionally, value investing often leads to dividend investing by default. Many companies that are well established and stable, without rapid growth trajectories will issue dividends to their shareholders rather than reinvest the cash for growth. This too can smooth out a bumpy market in your portfolio. So, regardless of where one is in the market cycle, value investing plays an important role in a healthy overall portfolio.

As mentioned above, growth investing has outperformed value over the last 15 years, with some variance along the way. Cheap money made it easier for start-ups and other high-growth companies to grow market share using leverage. And many companies built up a lot of leverage. We are seeing bankruptcies in that high-growth space now, especially crypto companies that essentially grew from obscurity to multibillion-dollar companies in the span of a few years using massive amounts of borrowing (or in some cases customer funds). The reckoning for growth stocks and relative outperformance by value stocks have been so severe over the past year that now around 20 “growth” stocks are trading at a lower price-to-earnings than their “value” counterparts in the large-cap index. This may be a sign that a bottom is near for growth companies or possibly the market in general. The growth index is down 25% this year versus just 5% for the value index. Chip maker Qualcomm and parent company of Facebook, Meta, (both growth companies) now trade at just 11 times earnings making them about half as expensive as Lowe’s and Home Depot and about a 65% discount to Nike. There may be some value in the growth sector.

It is impossible to tell precisely when one sector will fall out of favor for another, that’s why a balanced approach makes the most sense for most investors. Our philosophy is to both follow momentum and invest for stability (low volatility and value/dividend funds). The market is forward looking. It consistently tries to look 6-9 months ahead. Take for example the price action of video chat company Zoom. The stock price has been declining for months even as the earnings were growing. But in their latest earnings report they announced slower growth and the stock actually improved. The market anticipated the slower growth and beat down the stock in the previous months. But now it appears an equilibrium has been reached if not an expectation or renewed growth to come. The market anticipated and acted accordingly. The market has been anticipating value stocks to play a larger role in the new high-interest rate economy. While that is most likely true, we cannot count out the value that is hiding among the growth companies.

“Always buy your straw hats in the winter.” – Benjamin Graham

Earnings and Flow

Over the past several quarters we have discussed the Fed and their influence on the overall market at length. This time we would like to take a deeper look and zoom in to the company level. Last week closed out the Q3 earnings season for large industrial and tech companies. There were some major winners and losers and lots of drama along the way. Oil companies reported their strongest profits since the early days of the War on Terror and have by far been the best performing sector this year - surging over 65% year to date. Google fell below earnings expectations citing a slowdown in ad spending by businesses and headwinds internationally due to the strong dollar. The stock tanked 6% following the announcement. Amazon similarly got crushed after missing expectations and lowering their guidance for holiday shopping as inflation soars and wages stagnate. Apple, on the other hand narrowly beat expectations as demand for their products remained robust. The stock recorded its best day since 2020 by rising over 7.5%. Then there was Facebook. Meta (Facebook) reported a staggering increase in spending that sent many stockholders and analysts fleeing. The reaction was so sharp and strong it felt personal – declining over 20% in a single day. In fact, CNBC personality Jim Cramer was brought to tears feeling that he let his viewers down by leading them to a company that in his view betrayed them by burning through their free cash flow in attempts to create the new “metaverse.”  

As interest rates continue to rise, earnings are once again placed in the spotlight. Over the past year it has become more difficult to obtain cash from a creditor, and businesses must find ways to create and retain more cash than previously. A simple and fundamental concept that at times seems to be forgotten when the going is good, and money is cheap. High growth companies notoriously have poor earnings relative to their conglomerate and industrial peers because instead of retaining and returning revenues to investors they use their cash flow to grow the business. But as interest rates go up, more and more cash from revenue are needed to fulfill the growth needs as credit gets more expensive or dries up completely. The overall cash flow is diminished. Let us reflect on this concept of flow. Standing in a flowing river you always have access to water, just dip in your hand. In business it’s very similar. 

Take the example of a private company called Citadel. They position themselves in-between traders. In technical terms they are a market maker, in layman’s terms they buy what you want to sell and immediately sell it to another buyer. But they do so at a slightly higher price than if you were to have no middleman. It is estimated that they execute approximately 47% of all US listed stock trades. They are capturing the flow of stock and able to skim billions in profit while essentially taking no risk. Most businesses do not have such an elegant way to generate cash from the literal flow of cash running through them. Usually, a company has to convert their control of flow of some widget into cash profits. Once a company is able to do this and consistently generate cash it is prudent to protect that line of business. That’s what made Cramer weep. He felt that Facebook was uniquely positioned to capture a huge flow of the advertising market and that the cash flow generated from it should ethically be distributed back to shareholders (dividends or share buy-backs). And instead of doing that they invested in a business that is not capturing the flow of anyone or anything. 

Now that dollars are more expensive to borrow and economic output is low, positioning one’s business to capture and retain flow is maximally important. Oil companies literally control the flow of oil and the more expensive it is the better they do. In times of geopolitical strife, they are a good place to hide out. Apple is worth almost $2.5 trillion because it captures the flow of smartphones, apps, media, and advertising. Google, despite the recent sell-off, captures about 1/3rd of all online advertising revenue flowing by them and are well positioned to continue to dominate digital advertising. Amazon accounts for almost 40% of online shopping and much of the internet flow runs though the pipelines of Amazon Web Services (AWS cloud). Meta (Facebook) also deserves a second look. While it is irresponsible to spend tens of billions of dollars quarter after quarter on a product with few customers, their core business is unparalleled in human history. As of last month, 3,710,000,000 unique individuals used at least one of their applications (Facebook, Instagram, WhatsApp). That is just shy of half of humanity. A tremendous flow of human communication. In general, one should not let a bad quarter or year scare you out of a strong company. Companies with large market shares have tremendous pricing flexibility and protection, or in Warren Buffet’s words, “wide moats.” They can withstand downturns and recessions much better than low revenue companies in more competitive industries. Be patient and follow the (revenue) flow. 

We’ll leave you with an old Wall Street axiom, “Bear markets are when stocks are returned to their rightful owners.” 

Monetary Tightening

This month’s market update should be titled “How I Learned to Stop Worrying and Love Losing Money.” At least that’s what it feels like the Fed is telling us. The Federal Reserve has a pretty substantial credibility problem right now. A year ago this month the Fed was buying billions of dollars worth of mortgages (in the form of mortgage backed securities) amidst surging home prices causing home values to skyrocket. And doing this while stating that they did not see inflation on the horizon (spoiler alert, housing makes up about 1/3rd of CPI). A few months later in December, as they saw inflation ticking up, they stated the most they would have to raise rates this year to combat it would be 0.5%. Now, looking at the same data (home prices, jobs, energy) they are saying rates need to raise substantially, potentially to 4.5-5% for the Fed Funds rate, to quell the 9% inflation staring at them. The problem is the metrics used to measure inflation are backward looking. The Fed and investors understand this. Thus, policy actions taken by the Federal Reserve should follow accordingly and be pre-emptive rather than reactive. The Fed is mandated to facilitate price stability and maximum employment. On the employment side they are doing great (3.7% unemployment). On the price stability side, they are utterly failing. Not only is inflation soaring, but the value (market cap) of stocks and bonds in the US has declined by $57.8 trillion (based on Bloomberg data). At the very least they could express what they intend to look at going forward since they missed the mark so badly coming into this cycle.

Inflation was guaranteed to show up after the massive monetary expansion during the pandemic. The Fed increased the supply of dollars in the economy by roughly 41%, pushing up the prices on everything from stocks and homes to meat and fuel. Increasing the money in circulation is a healthy part of a functioning economy. A 5% increase in the supply of dollars correlates to roughly 2% inflation. If the Fed was not going to be comfortable with this current level of inflation we are seeing now, they probably should have made the treasury float their bonds on the open market to pay for the pandemic stimulus rather than buying them (printing money). This would have resulted in interest rates naturally going up as the supply of bonds in the market increased, potentially easing the transition to higher rates. Instead, what we got was very cheap and easy money and “dovish” speeches from the Fed through 2021, then an abrupt shift to monetary tightening pushing rates up faster than ever before. The dollar is at 20-year highs, commodity prices are declining, and the money supply is decreasing. The Fed is saying we need to remove money from the economy, and that we should all love this because it will drive down inflation. That’s all fine except for the fact that the economy is already shrinking, productivity is down, wages are barely inching higher, and trillions in valuation have been wiped out. Aggressively raising rates and removing cash will certainly tame inflation but it will do so at the expense of millions of jobs and people’s wages.

We don’t have a crystal ball, but here are some predictions of what is likely to happen. Inflation numbers will continue to look ugly in the Fed’s eyes as housing costs worm their way through the system. The Fed will want to continue rate hiking until it sees material deterioration in CPI, which could take over a year to manifest. During that time there will be an amplifying chorus from the business community and politicians to ease the pain as job losses mount and markets remain volatile. The Fed will eventually succumb, and their language will get more dovish with statements such as, “we are seeing a moderating of inflation” (even if they aren’t). At that time whether they cut rates, stop raising them, or do nothing the markets will rally. Inflation will then actually moderate as monetary tightening filters through the economy, market volatility will subside, and the Fed will get to decide if they want to start juicing growth by adding dollars back in – and the cycle will start over.

As an investor, the key is to remain diversified, disciplined, and patient. Every cycle rhymes but they are hardly the same script. How long a recession or bear market will last is anyone’s guess. But you don’t want to get left on the sideline (or worse, short) when the next bull market takes off. As has been stated here before and is still true today – stocks offer a better risk/reward than bonds and cash over time, even with increasing competition.

Soft Landing

The Fed has been talking about having their goal be a “soft landing ”for the economy –meaning avoid a recession and manage inflation as GDP comes down all while keeping the job market relatively stable. But as of last Friday ,when Fed Chairman Powell spoke at Jackson Hole it was clear that the new priority is to tackle inflation at the expense of a “soft landing”. Commentators are now keen to point out that this Fed does not want to go down in history as the one that let inflation run away. Part of this shift is most likely Powell trying to save face after repeatedly stating that inflation was “transitory” and would come down much sooner than is playing out. Although we have seen two consecutive quarters of GDP contraction, it is difficult to call what is going on a recession. The labor market is still very healthy. However, what economists are predicting going forward is known as a “growth recession”. This is where GDP does not go negative, but growth is very anemic and unemployment creeps higher. Investors fear this scenario because it is a slow drip of prolonged pain, thus the sell off on Friday and the days to follow. A short actual recession is preferred to that, but a “soft landing” as we sustained in 1994-95 when interest rates doubled and unemployment never rose is still not out of the question. The difference this time is that inflation is much higher than it was then and might prove more tricky to tackle. But even that points to the silver lining of this current economy. Inflation has been stubborn partly due to the fact that jobs are so strong. There is still a tremendous amount of money going into the hands of the American consumer. Unemployment is at 50-year lows. That makes it hard to drive the economy into a recession when 80% of it is composed of consumer spending. The bottom line is that whether we are in a recession, headed toward a “growth recession”, or experiencing a “soft landing”, stocks still remain the best risk-adjusted asset to be invested in over a multi-year timeframe. Valuations have come down and most S&P sectors look very compelling.