Stocktake: Recession risk – is it really that important?

In the past 10 downturns, the S&P 500 was actually higher seven times

"Fed hiking rates. Bond yields popping. Oil prices soaring. Think 1973-75. Think 1979-80. Think 1989-90. Think 1999-2000. And think 2006-07. And tell me a recession isn't coming our way". High-profile market strategist David Rosenberg, who was prescient when warning of danger in the run-up to the global financial crisis in 2007, reckons investors are again underestimating the potential for trouble. Rosenberg says Trumponomics – fiscal stimulus at a time of full employment – will cause a recession in the next 12 months. That's a contrarian call – recession odds remain very low – and financial blogger Urban Carmel was unconvinced by Rosenberg's recession list, sarcastically tweeting: "Aside from housing sales rising, UE falling, yield curve positive, inflation 80% lower and oil being positively correlated to equities, now is just like the lead-up to the last 5 recessions". LPL Research echoes Carmel's analysis, but adds that it may not matter too much either way. Looking at the last 10 downturns, it found the S&P 500 was actually higher during the recession seven times. A year after the recession ended, stocks were higher nine out of 10 times. Worry about a recession when the warning signs "pile up", says LPL, but don't panic; any weakness is not likely to be lasting.

Hedge funds not worth the money

Hedge-fund managers are skilled – just not skilled enough to earn their keep. That’s the takeaway from a new report, Hedge Fund Reality Check, by Canadian consultancy CEM Benchmarking.

Examining hedge fund returns reported by large institutional investors with simple benchmarks that combined stock and debt indices, CEM found hedge funds outperformed by 1.45 percentage points annually between 2000 and 2016.

Not bad, but that’s excluding fees. Once hedge funds deducted their usual hefty fees, investors actually underperformed by 1.27 percentage points annually over the period. Performance was especially bad when it was most needed, with hedge funds trailing benchmarks by six percentage points when markets crashed in 2008. Institutional investors really shouldn’t be coughing up for hedge funds when there are low-cost alternatives. Similarly, ordinary investors looking to hedge against market declines should stick to a mix of bonds and stocks.


The simple reality is that costs matter – a lot.

Buy-back ‘tidal wave’ is exaggerated

American companies are spending record sums of money on stock buy-backs. Should investors be concerned? Stock buy-backs support share prices. If companies are losing the run of themselves and spending unsustainable amounts on buy-backs, any future retreat from the marketplace could hurt share prices, the theory goes. Goldman Sachs recently estimated that S&P 500 companies would be behind $650 billion worth of buy-backs this year. Financial magazine Barron’s, reporting on the “growing tidal wave” of buy-backs, said this would represent a “smashing” of the previous record of $589 billion set in 2007. The Money Observer magazine struck a similar tone, noting companies spent a record $178 billion on buy-backs in the first quarter of 2018, just topping the previous record “set ominously in the third quarter of 2007”. However, the reality is more mundane than the figures might suggest. The US market has increased in value by about 80 per cent since 2007. If you adjust the figures for today’s much greater market value, then buy-backs are not nearly as high as they were in 2007. In fact, buy-backs as a percentage of S&P 500 market capitalisation have actually drifted lower over the past seven years.

Notably, today’s levels are below readings registered throughout 2005 and 2006 and are roughly half those recorded at 2007’s peak – hardly cause for serious investor concern.

Cynical fund managers buy lottery stocks

It’s well known that lottery stocks – speculative stocks where you have a great chance of losing money and a small chance of making big bucks – are a bad bet. So why do supposedly sophisticated fund managers buy them? The findings of a new study, Why Do Mutual Funds Hold Lottery Stocks?, make for depressing if unsurprising reading. Firstly, it confirmed that the more lottery stocks a fund holds, the worse it performs. Secondly, it found poorly performing funds increase their lottery holdings near the end of the year in a reckless effort to catch up with peers. Thirdly, and most importantly, it found such funds tend to be smaller, younger and more expensive and that they buy lottery stocks to attract naive retail investors. Funds with more retail investors and lower managerial ownership hold more lottery stocks.

Lottery stocks have always been popular with ordinary investors, and funds that substantially increase their holdings attract the masses – retail fund flows rise by 20-45 per cent over the following quarter, the study found. In other words, fund managers who buy lottery stocks aren’t ignorant – just cynical.