The Next Recession: When It Will Happen and How to Prepare

I’ve been thinking a lot about recessions lately.

It’s pretty hard not to, because warnings about recessions are coming from financial pundits and big banks with increasing frequency. Most recently, an economist at Citigroup warned in a research note that a recession was likely to come in the next 18 months, because the US Treasury yield curve is flattening.

This person isn’t a lone wolf.

Many economists, including a lot of wonks at the Federal Reserve, are fiercely debating whether our flattening yield curve is a sign that a recession is around the corner. And the fear is intensifying, since the difference between the yield on the two-year and 10-year Treasuries is a meager 25 basis points, the narrowest in over a decade.

This panic isn’t new—and it’s exactly wrong. For instance, Morgan Stanley was warning investors that a flattening yield curve was a serious risk back in 2015, meaning, in their view, that a recession was likely in the next couple years.

They were wrong.

That year, the world’s GDP rose 3.2%, then rose again, by 3.1%, in 2016, according to the International Monetary Fund. The US didn’t do too badly, either, growing 2.6% and 1.6% in those years, with additional 2.3% GDP growth in 2017 and over 3% GDP growth expected for 2018.

The economy’s improving growth shows that we aren’t anywhere near a recession, and, as I wrote in a June 20, 2017, article, it signals a great time to buy stocks. (The S&P 500 is up 17% since that article was published.)

Strong stocks and higher GDP growth are a far cry from Morgan Stanley’s warning. “Recessions follow expansions like night follows day,” warned the bank’s chief global strategist of emerging market equities, Ruchir Sharma, at a Bloomberg summit in 2015.

Except they don’t.

Nights follow days at regular intervals governed by the laws of physics. Recessions follow expansions because of human nature, and human nature is impossible to predict. Sharma’s grave warnings from two years ago prove the point.

49 Recessions—and Holding

Where does the seven-year myth come from? Recent history.

In 1969, 1990 and 2008, there were three recessions that were about seven years apart. We also saw a 2001 recession that came a decade after the previous one—near enough to seven years if you’re not looking too closely.

But that’s a misleading selection because we also saw recessions in 1973, 1980 and 1981 that weren’t anywhere near seven years after the preceding one. You could try to fudge the numbers to make them fit, but an even closer look at history shows just how foolish that would be.

Let’s take a look at the full list of every recession in US history.

That’s a long list!

In America’s near 250-year history, there has been no shortage of crises and panics. But the good news is that they’re getting further apart. It’s almost as if the economy is getting more efficient and businesses are getting better at avoiding downturns.

If you lived through 2008, you probably wouldn’t think that things are getting better, but they are. As bad as that crash was, we didn’t have bread lines like we did in the Great Depression; we didn’t have homeless camps in Central Park; and we didn’t have food riots like the Flour Riot of 1837 in New York City.

Of course, things aren’t perfect nowadays, but our downturns tend to be more measured, more controlled and further apart. Take a look at this chart of each recession in US history and the time that elapsed since the previous one:

Notice how the lines tend to get longer over time? That’s because we’re getting smarter about capital markets, fund flows, business cycles and ways to cushion the economy when things get really bad.

That doesn’t mean recessions are destined to happen every seven years, but it does mean that we can expect recessions to be spread even further apart in the future. Maybe someday, recessions will even stop happening altogether.

Life in the Slow(er) Lane

It’s now been nine years since the Great Recession officially ended in June 2009. That isn’t the longest gap we’ve had between recessions (that award goes to the post–dot-com recession of 2001), but I’m betting that the next recession won’t happen until it’s been a bit more than 10 years since the last one ended.

There are a number of reasons why I think the next recession is pretty far off, but they all come from the same starting point: the slow recovery we’ve seen over the last nine years.

Whether you call it “the new normal,” as ex-PIMCO bond genius Mohammad Al-Arian does, or you prefer “secular stagnation,” as Harvard professor and ex-presidential advisor Larry Summers does, everyone has noticed an uncomfortable truth about our economy since the Great Recession: it’s been recovering at a glacial pace.

That slow improvement has resulted in a delayed business cycle and slow growth in consumer spending. It has also caused overall wage growth following the recession to rise at a very slow rate—though it is now starting to increase significantly. That’s not a recessionary trend, but it isn’t a bubble either. It’s ho-hum.

And ho-hum is likely what we’re going to see for a few years to come. Again, not great, but not a recession either.

Steady Gains Ahead

What does ho-hum mean for investors? It means lower returns—but no major downturn.

Slowly, investors have begun to realize that this is a good reason to buy stocks. If you’re going to get lower average annualized returns over the next few years and you’re not going to get a major downturn anytime soon, that means it’s a really good time to buy stocks—especially since many are oversold due to fear mongering and too many individual investors keeping their cash out of the market.

(You could start with the 10 dividend stocks my colleague Brett Owens says are set to double. Click here to read all about them.)

Most retail investors haven’t gotten the memo that this is the new reality of investing, but the stock market has. Take a look at the volatility index known as the VIX. Called the “fear gauge,” this is an indicator of just how scared the market is of a major downturn in the near future. And its average has been trending down ever since the financial crisis began:

Volatility Still Falling

Despite the headlines about volatility rising earlier this year, fear is still going down over the longer term because the market is continually realizing that there are too many safeguards in place, too many checks and balances and too much at stake in the new world economy to let another 2008 happen. That doesn’t mean it won’t, but it does mean it won’t anytime soon.

And without a recession, there’s not going to be a bear market in stocks in the short term, meaning investors need to buy now and watch their portfolios grow. The only trap in today’s new normal is sitting in cash on the sidelines, where rising inflation will eat up your net worth.

Editor's Note: The stock market is way up – and that’s terrible news for us dividend investors. Yields haven’t been this low in decades! But there are still plenty of great opportunities to secure meaningful income if you know where to look. Brett Owens' latest report reveals how you can easily (and safely) rake in 8%+ dividends and never worry about drawing down your capital again. Click here for full details!

Buy These 3 Stocks Profiting from Trump’s Trade War

I like to look for what are called contrarian investments. That is, trades where Wall Street is piled into one side of the ‘boat’. When this happens, the ‘boat’ has a tendency to ‘capsize’ turning into very large profits for taking the opposite side of the trade that Wall Street is on.

There are several of these trades going on right now including shorting U.S. Treasuries, being long the U.S. dollar, being short commodities, and also shorting overseas markets and using the proceeds to go even longer with even more leverage in the U.S. on favorites like the FANG stocks.

The reason for the latter trade is that Wall Street’s perception is that the tariffs imposed on foreign products will hurt those economies even though history says just the opposite – that the country imposing the tariffs is hurt the most. So what I have done in my personal account is scour the globe for companies that are actually benefiting or may gain from the tariffs imposed by the Administration.

Don’t Ignore ADRs

This really isn’t hard, with many of these type of companies trading right here in the U.S. in the form of American Depository Receipts or ADRs. Some of these are large, well-known companies such as Alibaba (NYSE: BABA). Here is a quick overview of ADRs.

ADRs can be sponsored or unsponsored and have three different levels, depending upon foreign companies’ access to US markets, as well as disclosure and compliance requirements. Level 1 ADRs cannot be used to raise capital and are only traded on the over-the-counter market. Level 2 and Level 3 ADRs are both listed on an established U.S. stock exchange, with Level 3 ADRs having the ability to be used to raise capital.

Most ADRs that trade over-the-counter as easy to spot since the last letter of the five letters in their symbol is always a Y. For instance, the food giant Nestle symbol is NSRGY and China’s internet and gaming powerhouse Tencent symbol is TCEHY.

However, the number of ADRs listed in the U.S. has shrunk drastically in recent years. The reason for that lies in the cost of compliance with among other regulations, Sarbanes-Oxley. It is just not cost-effective for companies to spend millions of dollars to comply and then see little daily trading in their ADR thanks to lack of interest in foreign firms by U.S. investors (home bias).

If you do stick with ADRs, the commissions charged you by brokerage firms, such as Charles Schwab, is the same as for U.S. companies – $4.95.

Related: Buy This Export to China That Is Exempt From Tariffs

And if you’re worried about the accounting standards at foreign companies, don’t be. Listed foreign companies follow international accounting standards as set by the IFRS. There are differences between IFRS (International Financial Reporting Standards) and GAAP (Generally Accepted Accounting Principles) standards here in the U.S. But that would be a long, boring discussion we don’t have the time to get into.

Suffice it to say that IFRS standards are very good and better than the pro forma earnings numbers often reported here in the U.S., which I consider to be trash. As Warren Buffett has often pointed out, pro forma earnings often leave out real expenses, such as stock compensation.

Convergence between IFRS and GAAP standards have been a topic of discussion at the SEC and other governmental agencies for years. But interestingly, U.S. officials seems to dragging their feet. Maybe it’s because the U.S. doesn’t always have the highest standards for corporations.

Take Ali Baba (NYSE: BABA), for example. It listed here in the U.S. and not in Hong Kong because the corporate governance rules were less strict here in the U.S. The Hong Kong Exchange frowned upon the company wanting to nominate the majority of the board itself. Although now there is talk Hong Kong will adopt the lower U.S. standards.

Now let me move on and bring you three ADRs I found that are either benefiting from the tariffs or are unaffected. Keep in mind that these are major companies in their home markets that trade millions of shares a day there.

Soybeans Anyone?

One of most prominent retaliations taken against the U.S. was China’s tariffs on U.S. farm products such as soybeans. That immediately make me think of another big agricultural economy that China already bought a lot of products from – Brazil.

One of the largest agricultural companies in Brazil is a company named SLC Agricola SA that does have an ADR with the symbol SLCJY. The ADR is liquid enough for individual investors (I do own it) with trading volume of about 15,000 a day.

The company, founded in 1977, has an English website slcagricola, so it’s easy to get information on it. The company has 16 production sites located in six Brazilian states totaling 404,479 hectares during the 2017/18 crop season. The acreage breakdown is: 230,164 of soybeans, 95,124 of cotton, 76,839 of corn and 2,352 of other crops, such as wheat, corn 1st crop, corn seed and sugarcane.

The ADR has taken off in recent months and is now up 100% year-to-date and 140% over the past year. I’m sure many Brazilian farmers, as well as Agricola shareholders, are thankful tariffs were imposed.

Germany’s Square

Another favorite target seems to be Germany, so I looked to see what I could find there. And I came up with a global leader in the payments space, a company named Wirecard AG that has an ADR with the symbol WCAGY. Its ADR also has decent liquidity with about 10,000 shares traded daily even though it only became available in late 2016.

 Wirecard is one of the fastest growing financial commerce platform that services 36,000 large- and medium-sized merchants and 191,000 small-sized merchants. It had over $106 billion in processed transaction volume worldwide in fiscal year 2017.

The company works together with ApplePay in many European countries. And it bought Citibank’s prepaid card services in North America as well as its merchant acquiring business in the Asia-Pacific region.

Due to its strong organic growth in excess of 25%, management raised its guidance in April for the 2018 fiscal year from 510 million to 535 million euros up to 520 million to 545 million euros. This has not been lost on investors. . . . .

Its ADR is up 60% year-to-date and has soared more than 143% over the past year.

It’s Not Made Here

The final ADR is one that is thinly traded (only a few hundred shares daily). But I wanted to bring it your attention because it makes something that is NOT made in the U.S. meaning that barriers or not, it is an absolute necessity for some firms. Let me explain. . . . .

If you’re having trouble finding some electronic devices, such as a Sony Playstation 4, it is likely due to the ongoing global shortage of MLCCs, or multilayer ceramic capacitors. You may never see these capacitors, which are less than one millimeter on each side. But they are a crucial component of your smartphone as well as your car. They help control the flow of electricity and store power for semiconductors, without which no electronic device will function.

The market for MLCCs is dominated by Asian manufacturers with just three companies controlling 60% of the market – Korea’s Samsung Electro-Mechanics and two Japanese firms, Murata Manufacturing and Taiyo Yuden. Both Japanese companies have ADRs trading in the U.S. with the symbols MRAAY and TYOYY respectively.

Murata has more liquidity, with over 18,000 shares traded daily versus just a few hundred shares. But Taiyo Yuden is by far the better performer. Even before the shortage occurred, Taiyo Yuden saw its sales of capacitors increase by over 21% in its last fiscal year.

That helped send its stock skyward. Its ADR is up 87% over the past year, with most of the performance occurring this year – up 82.5% year-to-date – as the realities of a global shortage of MLCCs have set in.

There you have it – just three of the overseas companies that either are benefiting or will be unaffected by tariffs. There are plenty more too, so please do not be afraid to put a little bit of your portfolio into stocks outside the U.S.

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Source: Investors Alley