December 19, 2022

Investing in the face
of a recession

Guest: Jason Richey, CFA, Co-Portfolio Manager at Cougar Global Investments

In this episode of Markets in Focus

With recession looming in 2023, it’s worth considering how much the Fed can even do at this point, and whether monetary and fiscal policies have a chance of cushioning the shock once again. Jason Richey, CFA, Co-Portfolio Manager at Cougar Global Investments, provides insights on U.S. versus international markets, minimizing risk, and positioning portfolios for an economic slowdown.

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Matt Orton:
I think it's safe to say that inflation will go down as the word for the year. And if I had to guess, I have a strong sense that the word of 2023 is going to be recession. Whether it's a soft landing, a softish landing, a hard landing, a mild recession, or a deep recession, it's absolutely impossible to go one single day without hearing about where the economy is heading. And I don't expect that's going to end when we get into 2023.

While the jury is still out on how bad the going will get, it's pretty clear that economic growth has materially slowed and there are definitely challenges on the horizon. But what gets missed in so many of these cursory summations of slowing growth are the direct implications to financial markets, one of which is how could earnings be impacted by a recession? Certainly, 2008 or the COVID lockdowns are not the norm. Further, how will recession differ across geographies? What about the possibility of a tail event, like the systemic shocks of the Global Financial Crisis, and what does that mean for markets?

This is Markets in Focus from Raymond James Investment Management. I'm your host, Matt Orton, and I invite you to join me and my colleagues as we discuss the latest trends and developments driving the markets. Visit us at for additional episodes and insights.

To help think through the varied implications of recession and what we should be thinking about from a tail event perspective, I've asked Jason Richey, Co-Portfolio Manager at Cougar Global Investments to join us again and provide some insights on how ultimately, we can position from an investment standpoint. Jason, thanks for being here today.

Jason Richey:
Thanks, Matt. It's great to be here with you again.

Matt Orton:
It's always great having you back. And maybe to start things off, it's clear that economic growth is slowing, and I think it would be helpful to get your thoughts on the proper descriptor. Do you foresee a softish landing, a moderate recession, a deep recession, or maybe none of the above?

Jason Richey:
That is, of course, the question. And, yeah, it does sort of seem like a parlor game. All these different variations of landings. Reminds me a bit of all the letters that we tried to use as different descriptors coming out of the pandemic in 2020. Would it be a U-shape recovery or a V-shape recovery? Would it be some sort of flat line L, or maybe a W shape resembling a double dip? And if you remember back then, letters were all the rage, and this time we're forced to pick somewhere on this soft to hard landing spectrum, as you referenced. Now, we've had a lot of market, a lot of economic risk present for quite some time. It just looks like now that's manifesting in slower economic trends and slower growth.

For now, I think consensus has broadly moved towards recession as a base case, though I don't think we have enough data yet to forecast a definite hard landing. Again, hard landing is a relative descriptor. To me, a hard landing is something in the 2007, 2009 category, where there's some type of systemic risk, maybe some type of risk where you can't access your bank account or perhaps your ATM card doesn't work. I think that's what the market's trying to weigh right now. At this point, I think most people have conceded some type of economic pullback, but is it going to be a short and shallow recession? Is it going to be a longer and deeper recession? Just given where the jobs market is right now, I don't think something sinister is definite. But my approach is effectively to cross my fingers and hope for something boring, and then be prepared for something a lot worse than that.

Matt Orton:
Who would've thought boring is good? And I think that's definitely the case, given the daily volatility we feel. And to dig in a little bit deeper, maybe you could provide some context around what say, a run of the mill recession actually looks like versus something more calamitous like you mentioned say, the Global Financial Crisis in 2008 and 2009.

Jason Richey:
I agree. It's hard to define what a, quote, normal type of recession would even look like anymore. 2020 was hopefully a once in a lifetime experience with the pandemic. Perhaps Bill Gates would argue with that, meaning there could be more frequent occurrences in the future. You mentioned 2008, back then there were a lot of comparisons to the Great Depression at the time. So that's certainly on the bad side of things. I don't know, does the tech bubble count as a normal recession? Maybe. Maybe you have to go back to 1991. For me, the problem is that once you go back further into the past, and for me that's pre-2008, the biggest challenge to comparing time periods is this impact that monetary policy and overall debt has had. And what I mean is, before 2008, we didn't have a Fed balance sheet to speak of and we didn't have this concept of quantitative easing.

Central banks and monetary policy, and fiscal policy, for that matter, are certainly much more influential in today's marketplace. But your question is trying to define a recession. So, if we're trying to define it, I'll say one interesting way to define, again, a run-of-the-mill type of recession would be based on how far the equity market falls. And again, that seems, at least to me, to be very correlated to the leverage in the system today. If you want some data behind that, there's an often-quoted statistic that we hear lately, and that’s median returns during a recession are somewhere around minus 24% or minus 25%. That is true, except that when you dig a little bit deeper and you start looking at the data around the 12 recessions since World War II, 2007 was the worst, with a 56% loss for the S&P 500. 2001 was the second worst, with a 49% loss. And 2020 was probably cut short and we only lost 34% in the S&P 500. But who knows how much we would've lost if there wasn't such swift government intervention at the time?

And my point is there's just a lot of leverage in the system today. Based on that, the trend is not looking good in terms of recent recessions having much deeper impacts on equity markets. I don't know at this point that I would say, hey, the market's lost 25% this year. That happens to be the median downside return during a recession. So, we're in the clear here in terms of equity market returns. It doesn't feel like a very comfortable statement to me.

Matt Orton:
Well, that's the beauty of statistics and pulling historical analogs There's something for everyone. You can pick your recession or pick your drawdown and come up with what you want. But maybe to dig even a little bit deeper on that point, we like to talk about the drawdowns in the equity markets, but what about the actual impact for corporate earnings? Because, again, I'm going to move back historically, but it is worth pointing out that not all recessions have been equally troubling for corporate earnings. And if we are using just recent recessions as a guide, maybe they provide faulty guidance on what's to come if you're anchoring to the Global Financial Crisis.

I'd love to hear how you think earnings might evolve over the coming quarters. And perhaps, more importantly, how do you think margins will hold up?

Jason Richey:
You're right. Everybody does anchor to the financial crisis of 15 years ago. The worry today is that we'll have something worse, or significantly worse than a 20% pullback in earnings in 2023. And then you can pick your forward multiple, whether that's 13 times or 15 times earnings. You do that math, and the bottom line is that gets you to a really awful S&P 500 Index level number. I know that we all live quarter to quarter, but the focus in recent months was that you start to see this fall in Q3 earnings. And, yeah, this quarter is weaker so far and it will probably continue that way. And yes, energy is masking some of the overall weakness, but none of that's a surprise at this point. I think the bigger surprise is that earnings might eke out a positive number this quarter. Quite frankly, it's probably a win given, all the fear that we had going into it.

Could we see a fall to $200 in aggregate S&P 500 earnings next year? Right now, there's too much consumer demand for it. If you happen to be in the longer, nastier recession camp, that's certainly a possibility. And as far as margins go, you can argue about earnings. I do think it's harder to argue about margins. They were already higher than usual going into this. So, now you throw in higher wages, you throw in sticky inflation in the supply chain and intermediate goods, and now that we have higher cost of capital with interest rates that aren't at zero. Unless you have a spike in productivity from employees, and that does not seem very likely, at least not in the near term. Margins almost certainly have to reset back to something lower from here.

Matt Orton:
That's all really, really helpful context. And so far, we've been really just U.S.-focused through all of this discussion, but we can't really forget about the rest of the world, either. Earnings for international companies have been holding up quite well, even though I'd say the economic outlook and situation overseas, and particularly in Europe, might be a little bit more dire than where we are here in the U.S. I would argue there's a lot of skepticism that the earnings holding up better overseas is going to be sustainable.

What are your thoughts on international, within portfolio allocations, with respect to how earnings are holding up, and do you think there's any parts of the international market that might be more attractive than others?

Jason Richey:
Certainly. That has been an ongoing debate for years. To me it's kind of like, interest rates have to rise, interest rates have to rise. And then, of course, interest rates rise and then we get a lot more than we bargained for. I can tell you what we were thinking going into the year, going into 2022. Most macro folks, most investors in general, look at historical relationships and then we try to find comparisons. And for us, part of that's also being on the lookout for extremes. And one of those extremes in relationships in performance that did happen last year, in 2021, and that was where global markets ex-U.S., meaning (the MSCI) ACWI, or the All Country World Index, less the U.S., those markets were up almost 8% in 2021. Which is great, except that the S&P 500 was up almost 29%. That 21% differential was the largest in the history of the ACWI ex-U.S. index.

So, it doesn't have to reverse. We all know that things don't work out on neat calendar timelines. But we thought, again, going into this year, that hey, the U.S. has had a nice run for a decade. It could be time to put some money to work internationally. If you go back and look early in the year, global equity indexes were outperforming the U.S. index by a lot, something like five percentage points. Then as you mentioned, with the geopolitical circumstances changing, the war changed everything. At this point, you have a recession either occurring or at Europe's doorstep. China has so many problems they're not even going to release GDP estimates. And the question at this point has switched to how far other regions will drag down the U.S.?

I think there are still some reasons to be optimistic about international just based on valuations and the thought that the dollar can't go up forever. But I think for most U.S.-based investors right now, they'll probably just hunker down close to home and revisit that issue later in 2023.

Matt Orton:
I think this is a great time to transition to risks. Just as we talked about with international, there's a lot of risks to any forecast that we have. And we've been hearing a larger choir saying that the Fed might be moving too fast, risking a deeper recession than markets are forecasting. What's the likelihood, in your opinion, that we see some of these risks materialize?

Jason Richey:
Well, it's looking a lot more likely every day. Now, again, to be fair, we started the year with many folks expecting interest rates to rise. Certainly not to the extent that they did, and it's really been a catastrophe for bond investors this year. As far as the Fed goes, the problem is we all need somebody to blame, and we might as well blame the Fed. I don't think it's all that fair. Fiscal policy has certainly gotten us in this mess, too. But since both political parties seem to spend, the Fed makes for the easiest target.

When you think about it, what can the Fed really do? Sure, they can manipulate financial markets, they can push and pull interest rates in whatever direction they want. But they can't fix European energy, they can't create more housing supply in the U.S., which has been a problem for a long time. And they can't create more workers, and that's also a big part of the problem. They're just stuck with trying to slow demand to essentially slow inflation, but that's really all the Fed's got. It's just really a very unique time right now, and the only way out of this mess seems to be a recession. But even then, I think it might only be a temporary lull in inflation, meaning we could see inflation pick up again a year or two from now.

Just to pick one example, if you look at new car sales, we're already basically at recessionary levels. I know that's because of supply chain issues, but my point is you might not get a lot of relief there. Let's suppose that we're in a recession a year from now, then what does the Fed do? There's a chance that the Fed pulls back and then inflation comes back. And then, if that happens, that very well could put the U.S. on a very similar path as it was on during the 1970s. Back then, there were waves of inflation for a decade and interest rates were all over the place during that time.

Matt Orton:
Those are all great points, especially for where we are now. You forget that we're coming off such historically low levels. If inflation does come back, as you said, what can the Fed really do? Because rates are still, I would say fairly low, with respect to previous history. And that brings up this notion of tail risks that I started this conversation with. Tail risks are ways to measure the probability of an asset performing significantly below or above its average performance. To me, it’s inherently the probability of a very unlikely event.

So, Jason, what are the causes of some of these tail events in the market, or that could be tail events? And what unlikely events do you think might happen as a result of what we're going through?

Jason Richey:
You are exactly right. Tail risk goes in both directions. Though, as much as investors would really like to catch periods of above-average performance, the real risk, as behavioral economics has effectively shown at this point, is that investors have to avoid downside risk because that's a lot more painful for them to experience. Tail events happen all the time in different portions of the market. And I think they're going to happen much more going forward than they have historically.

Part of that is just because markets have grown and developed so significantly over the past 20 years. I mean, we have prepackaged leveraged products today, just as one example of, I'll call it risk waiting to happen. We have all sorts of different debt financing today. We have much more complicated capital structures. There's a lot of available private equity and venture capital money out there as well. Then you pair that with fast-moving innovations around something like language processing or neural networks.

Again, you combine that with algorithmic trading as we've seen, spending much of the past year watching certain securities rise and fall by 25%, 30% and sometimes more. That can happen in a single day. That's just everyday activity in today's market. And it's not even counting any litany of geopolitical risks that could cause a market event. For example, what if we woke up one day and the U.S. no longer had access to advanced semiconductors from Taiwan? That's more than obviously a tail event for all sorts of different types of securities.

Matt Orton:
As you were answering, and even in the previous question, the one adage from Silicon Valley that came to mind is the notion of move fast and break things. I think you can apply it, as you did, to how securities trading is evolving, and also to maybe what the Fed is doing. That has a lot of investors worried about a potential left tail event. Cross-asset volatility is incredibly high. The MOVE Index, which looks at rate volatility, is basically back near levels from March of 2020, which is just crazy when you think about how extreme it was back then. So, what are your thoughts? Could something actually break? What might that look like? And has the market even begun to price in such a scenario?

Jason Richey:
That's what we're all searching for. I don't think the market has priced in something like that. Again, if you think of those recession returns in 2001 or the Global Financial Crisis in 2008, when things were breaking and the market fell 50%, right? So, today we have currencies that shouldn't move 1% in a day, but they are. There's just a ton of incredible moves that we're seeing out there. You referenced yields. As a bond investor, it's pretty inconceivable that you could lose 15% to 20% of your money, but that's basically what's happened this year.

The Bank of England is another example, raising rates, then buying bonds for a couple of weeks to effectively protect pensions. Then selling bonds again. There are tax policies changing back and forth. Stuff like that is the very definition of unpredictability. And it helps to explain one example of why we see such yield volatility. I think the biggest problem is we've been conditioned to believe that something could break and fiscal or monetary will save the day and come in as the buyer of last resort. I suppose that's as good of an assumption as any out there, but what if that doesn't work, right? At what point will policy really be tapped out? Maybe policy can't be tapped out.

I do think it'll be interesting to see if we go three-for-three in terms of policy working like a charm. What I mean is if you go back to the crisis, we had the $800 billion American Recovery and Reinvestment Act back in 2009. That signaled the market bottom. Markets took off from there. We had many trillions spent during the pandemic in 2020. Markets immediately turned even faster that time around. Would the same thing happen in a high-inflation environment in 2023? I mean, I don't know. I guess perhaps I'm just not totally conditioned to believe that it will work going forward.

Matt Orton:
Let's put all of this together. How should we be thinking about these left tail events, or some of the risks that you've highlighted, from a portfolio-construction perspective? Options come to mind. They can certainly play a role as well as some tail-hedging programs. But what about just simple asset allocation? This year, I'd say being tactical has worked, but it's been painful for someone who was using fixed income as a ballast.

Jason Richey:
I agree. First of all, on options. Options are a great way to hedge, although I think you really want to hedge when the VIX, a volatility index, is lower. But options still work. They're just more costly. But from an asset-allocation perspective, as you pointed out, I can give you both sides. The terrible part of this year is, quite frankly, a lot of hedging didn't really work that well. As usual, we often see this in times of real stress. Asset classes move in tandem. Diversification doesn't really work all that well.

So, for all the talk about portfolios of 60% equities and 40% bonds being dead, what we'll call the old tried-and-true 60/40 portfolio, 2022 will certainly go down as the year that that was true. 60/40 was certainly dead in 2022. But at the same time, so was 20/80, so was 80/20. Or really any of the other flavors of traditional. Call it boring asset allocation. But here's the thing: we spent a lot of time as an industry the past three or four years talking about the coming death of 60/40. I think what most people expected was a much slower death over multiple years, with a nice slow rise in yields back up to 5%. What I don't think is anybody projected one of the worst years in history for bonds, if not the worst, and the most aggressive Fed in 40 years.

Because of that, I think the 60/40 portfolio concept will come back to life in 2023, maybe even beyond that. But I do think it'll just take some time because we're going to be reading well into 2023 about how terrible diversification was in 2022. There are a couple of assumptions there. You do have to believe that yields are getting near the end of their rise. I think that's reasonable. But if you believe that's the case ... and today you can get actual yield in fixed income. Hopefully, that provides a buffer in 2023, especially if you think that there's some ongoing equity-market risk from here.

Matt Orton:
All right, Jason. So now that we're running out of time, I want to finish with some outlook. And, as a manager with downside risk mitigation as your core ethos, I'd say you've done a good job of managing the downside volatility that we've seen in 2022. But, as you look into the end of the year and into 2023, what are some of the best opportunities you see going forward? And is there a canary in the coal mine?

Jason Richey:
Thanks a lot, Matt. I really appreciate the kind words. From here, I'd like to say that we have this nice, seasonal bounce back into the end of the year. I think we'd need less Fed, we'd need fewer geopolitical events, we'd need better inflation data. By the way, all of that is more possible going into 2023. I know that everybody wants to reference the 2009 rebound, where the market was up almost 20% by the end of the year. But if you go back and relive the year, the S&P 500 was down almost 30% in early March in 2009 before it started that massive upward trend. So that was pretty painful back then.

In terms of the economy, we still haven't gotten the job losses that you have to believe are coming. We know that baskets of leading economic indicators have turned. There is some worry about inflation expectations getting out of control, that they've come in lately. There are plenty of things to monitor. In terms of market trends, high-yield spreads are not yet out of control. That's been interesting, just watching how poorly investment grade has performed relative to high yield. Small caps have been interesting lately too. They haven't completely fallen out of bed.

My guess is there's some of the domestic element there, but usually small caps lead the way both on the way up and on the way down. And I still think a 4% or 4½% two-year Treasury is just about as great a deal as you can get, especially if you think that we're going to be in a deep recession. But I'm going to try to end here on a note of optimism, since we're running out of time. I think that this is a year where we could all use a bit of optimism, so I'm going to try to offer it up.

Let's suppose that the year ends somewhere down, minus 20%-ish for the S&P 500. If that happens, it would be the fourth worst year for U.S. large caps since 1950, nearly more than 70 years at this point. Now, the other three times where the worst returns occurred, the returns during the following calendar year were actually pretty great. In 1975, the S&P 500 was up 28%. In 2003, the S&P 500 was up 22%. And then in the previously mentioned 2009, the market ended up almost 20%. So, if you're looking for a note of optimism, or on that bright note, as bad as 2022 has been, perhaps, just perhaps, there's something to eventually look forward to in 2023.

Matt Orton:
I like it. I'd like to end in optimism. Thank you very much, Jason, and thanks for your time. This has been really, really helpful. Thank you very much to our listeners for tuning in. Hopefully you found this as valuable as I did. And until next time, take care.

Thanks for listening to Markets in Focus from Raymond James Investment Management. You can find additional episodes and market insights at You can also subscribe to our podcast on Apple Podcasts, Spotify, or your favorite podcast app. Until next time, I'm Matt Orton.


The iShares MSCI ACWI ex U.S. ETF seeks to track the investment results of an index composed of large- and mid-capitalization non-U.S. equities.


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