Where's That Recession We Were Promised?

Aren't we supposed to be in a recession right now? Adam and Kyle Cipperley, Trust Investments Manager at First National Wealth Management, are breaking down what causes an economic downturn, what investors should do when one hits, and why we never got the recession experts swore would happen in 2023.

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Transcript

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- Where's that recession we were promised?[upbeat music] Welcome to "Common Cents on the Prairie", a podcast dedicated to helping you demystify the sometimes complex topic of money. I'm Adam Cox, head of Wealth Management for The First National Bank in Sioux Falls. We're a community bank based out of South Dakota. In this podcast, we share expert insights from around the country and stories from our local community to arm you with the tools you need to make better financial decisions. Because the truth is, the more we talk about this stuff, the better off we're all going to be. Today I'm joined by Kyle Cipperley. As you likely know by now, Kyle leads our investment team and is always reluctantly willing to join the show. On this episode, Kyle and I are going to discuss what's going on in the markets, how we got here, and how you can take advantage of these current market conditions. I hope you enjoy this episode. Kyle Cipperley, good to have you back. A couple questions to start off. Well, maybe it's a two-part question. First statement. Last time you and I talked on the show, we talked about music and you professed to the world your love of jam bands. First question. Are you surprised by how many people have seen that clip and commented back to you about it? And second question, if you had to pick one jam band to rule them all, who would it be?- Yeah, I've been surprised by the reaction I've gotten from that question.[Adam laughs] I think some people saw that, and I think they picture me as one of those guys at the Grateful Dead concerts just kind of roaming around in tie dye and stuff like that. I just want to make it clear to everybody out there, that's not me.- That's not, okay.- My favorite jam band, I mean, in college I was a big Dave Matthews guy.- Who wasn't?- So, you know, I'm not really, I wouldn't say the jam band, but my two favorite bands right now are probably The Lone Bellow and Caamp, which nobody watching this or listening has never heard of, but I really like them.- Incorrect. I have downloaded Lone Bellow songs because I still buy music one at a time because I'm ancient.- You got the cassette, too?- Yeah, we already, [laughs] exactly, and I saw Caamp live.- Really?- I didn't care for them.- Okay.- Yeah. I liked the acts on either side of them. I didn't care for them.- That doesn't surprise me. Go ahead.- That's fine. But, you know, I'm not one to knock on music. Chris Stapleton put out a new song the other day from his new album. I almost had to take the day off, so. [laughs][laughing together] All right, today we're going to talk a little bit about markets. We don't do this very often, but we are in an interesting time and we get a lot of questions about markets, what's happening and what's coming around the corner, so I thought we'd chat about that a little bit today. But before we dive into what's happening right now, I thought maybe we'll just do a brief history lesson because I think it's instructive to lead into where we're at now and what might be coming. So, just for everyone's benefit, let's start back in 2020. So we got hit by the pandemic. Basically everybody got told to stay home. The government pumped a bunch of money into the system and we all used it to buy furniture or fitness equipment or whatever the heck we bought. And the markets, I mean, they took a dump, frankly, right away at the beginning of the pandemic, but then they rallied. And I think the S&P ended up something like 16% up, something like that for 2020. Then 2021 comes. The good times kept rolling. S&P again, up huge, so it was like 27%, something like that. All-time highs. Everything worked. And 2022 comes around and that was like a punch in the face. And so, nothing worked in 2022. And stock market, way down. Bond market, also way down, which is surprising because normally in times when the stock market is not doing so hot, your bonds are there to help kind of keep your portfolio up. That didn't happen either, and some people have called it like the worst year for bonds in history. So, before we launch into 2023, Kyle, I'd love to get your big takeaways from 2022 because that'll help kind of frame where we're at right now.- Yeah, so if you go back to the beginning of 2022, where were we? We had interest rates at zero. You were earning zero on any safe money that you had set aside in a bank account or in short-term bonds. The 10-year government bond was at around 1.5%. And then in March the Fed started raising interest rates and they took rates from basically zero up to 5%. And they did that because inflation was a lot higher than they wanted it to be. And when you take interest rates up that fast, it breaks stuff, and so that's the main reason why the stock market went way down and bonds had such a rough year. And the lesson from that, of course, to me at least, is that it's always the stuff you're not worried about that gets you into trouble with investing, right? Going into 2022, nobody was talking about Russia, Ukraine. Nobody really was predicting interest rates ending the year around 5% or what have you. And so the lesson there is to expect the unexpected, to expect you're going to have surprises. And so anytime, you know, a lot of people in my seat and in this industry like to make a lot of predictions about where the economy's going to go and stuff like that. And I always just kind of take it with a grain of salt and don't pay much attention because it's not that we aren't good at predicting the economy most of the time. It's just that it's the surprises are that all that matters when it comes to investing and it comes to markets. The big down movements, whether it's COVID-19 or Russia/Ukraine, whether it's interest rates going from zero to five or Pearl Harbor, 9/11, it's always the stuff nobody's talking about that causes the biggest disruptions. And so 2022 is just another example of that, where you got surprised by a couple of things and that's what caused big moves. And so how does that affect how we manage money then for our clients? We just take the approach that we are always expecting one to two recessions a decade, you know? To be surprised. And so 2022, I was actually pleasantly surprised by our clients and how calm they were throughout the whole period. And I think that was a big takeaway for me about 2022 as well, was that I would've expected clients to have a much tougher time last year, and frankly, they didn't. They rode through it pretty well, and I think that might be just because in the back of people's minds, they understood maybe we got more than we deserved from the markets during COVD in 2020 and 2021. And so we just sort of felt like we were giving back some of the gains that were all gotten or that were not deserved maybe. And then with the interest rates, although going from zero to 5% is painful for a bond portfolio that you already own, it is nice in that it felt like a pay raise a little bit. You know, for much of the last 10 to 15 years, savers have been really penalized and borrowers have benefited from low interest rates. And so I think as I looked across our client base, our conservative investors finally able to earn some interest. Unfortunately, inflation was also present, so you didn't really feel like you were making much progress, but being able to earn 5% on cash, it's been a long time, and I think that is a positive coming out of 2022. So a painful year, but I think where we sit now, it's a positive.- Well, I think it also helped too, that, you know, I think we do a pretty good job talking a lot with clients about what to expect. And we're not people who are always, it's always going to be, the sun is always going to be shining and it's always going to be 70 degrees. That's just not the reality, especially not in South Dakota. So we do, I think, do a lot of coaching with our clients to say, you know, every few years there's going to be something that is going to unexpectedly come up and be an issue for us. We just have to be prepared for that. And I think that's a lot psychological. If you talk about it beforehand, then when it does come, you say, we've been preparing for this and we've structured your portfolio appropriately. So, all right, so that was 2022. We're in August of 2023 now, which is kind of hard to believe. What have been your takeaways from this year so far?- Yeah, I think for this year, everybody's surprised how well the economy is holding up. I think everybody would've expected we'd be in a recession or just stuff would be broken in the economy, especially like the housing market with how fast mortgage rates have moved up, but the economy seems to be doing pretty well. I think the good news is the inflation seems to be coming down. It comes down every time they report it. It's still too high compared to where the Fed wants it. They want it to be 2%, and right now it's according to their measure about 4%. And so we still have some ways to go, but I think everybody's relieved that it's stopped going up, that inflation seems to be coming down a little bit. And that unemployment is still really low. People still have their jobs. And that's kind of the simple way I look at it. As long as people have their jobs, they're going to spend money, and as long as people are spending money, the economy's going to do okay. I think that nobody would've expected the stock market, including me, to be up 20% this year. In the case of the S&P 500 index, it's up 20 and a half percent. Part of that's because the biggest companies, the big tech companies that were down a lot last year are up a lot this year, and so it's just a little bit of rally in those stocks. If you just look at the what are called the equal weight S&P 500, which give you an idea what the average stock is up this year, it's about 10%.- Okay.- So not as good as the S&P 500, but still stock market is extremely strong. Interest rates keep ticking up a little bit. The Fed just raised rates again last week, but the economy seems to be kind of humming along and I think that year-to-date has been a big surprise.- Yeah. To me just kind of watching that, obviously not as closely as you, it's felt a little bit uneven. You know, I think some of the biggest companies are doing really, really well, especially some of the biggest tech companies, particularly if they're in the AI space. They seem to be really having some outsized gains and people are really paying attention to that, and I think there's some peaked interest in,"Well, hey, maybe we should load up our portfolios a little bit more with that." And maybe one of the cautions that we always give is to like, okay, well let's look back at even recent history, and some of those same companies got absolutely crushed last year. And so while they are up big this year, they're just kind of coming back from the lows where they were last year. And so that equal-weighted index I think makes a little bit more sense, because there are still parts of the economy that aren't doing as hot. And, you know, we've had a banking issue this year. Not everything is on fire, so that makes some sense to me. So, you talked a little bit about interest rates going up and the Fed is raising interest rates at the fastest pace in 40 years or so. Basically what they're trying to do, cool the economy and get inflation back down to its target of 2%. And in so doing, the yield curve is inverted, and so there's lots of warning signs that are out there. And in 2022 and early 2023, all the experts, you mentioned experts, they have been breathlessly predicting that we would be in a recession in 2023, like full-stop, guarantee we're going to be in a recession. So I guess the natural question becomes, where's the recession?- Yeah, I think first it'd be helpful to understand what a recession actually is. It's one of those words everybody throws around. I think generally everybody knows what that is, what it looks like, but some people refer to a recession as two consecutive quarters of negative GDP growth. In other words, the economy's slowing down. We actually had that in 2022, but we didn't call it a recession because there's actually a committee of eight people on something called the National Bureau of Economic Research or NBER.- Okay.- They get together throughout the year and they look at various factors on spending, industrial production, incomes, et cetera.- Sounds like a party.- And yeah, right. And they decide whether or not we're in a recession. So it's kind of a committee decision whether or not we're in a recession.- [Adam] Interesting.- And they document past history of recessions and that's kind of their purpose of the committee. Well, so far they haven't said we've been in a recession, but they don't ever say we're in one until it's already over or it's already started, and so you don't really know for sure. But I would say that sitting here today, as soon as this goes public, we'll probably be in a recession or something,- Sure.- But, like, sitting here today, it looks like we're not in a recession. The last GDP report was positive and people still have their jobs and are spending money and and so forth. But, you know, what will cause a recession would be something that we're not expecting, something that we're, it's the unknown unknowns, if you will. It's the stuff nobody's talking about that really could throw us for a loop. That's what caused the last recession in 2020, even though it lasted like two months because of all the government bailouts and so on that occurred during COVID. That was the last recession we had. The one before that was in '07/'09. That one was a little bit more acute and more painful. It lasted longer. So this time around, who knows? You kind of knew we weren't going to get one once everybody started speaking with some certainty that we were going to get one this year.- [Adam] Yes.- People that normally would say,"Yeah, there's a 40% chance of a recession," just so that they could never look too wrong started saying 90% chance earlier this year that we'd get a big recession in 2023. And once I started hearing that, I'm like,"Well, we're probably not going to get one," because that's kind of when, kind of what happens. It's when everybody's expecting something, it's usually smart to like go the other way. So, I don't know when we'll get a recession and what will cause it, and I just repeated an earlier point, which is that our approach as investors is not in predicting when a recession will come and then try to sell everything and sidestep it. That just never works, you know? The economy just isn't predictable in that kind of way. So the way we approach it mentally and the way that we coach our clients on it, frankly, is that it's like a snowstorm in South Dakota, right? We know they're coming. We sort of know to expect them. We know how we're going to react when we get them, but it might not snow the entire month of November or something like that, right? So you just have to, but that doesn't then reduce the chance that we won't get snow in December or anything like that. So we just approach investing and managing our clients' money that we know we're going to get a recession. On average historically, it's two a decade, and so we just expect that. We don't predict when they come but we expect that they're going to happen and we plan accordingly. We plan accordingly by making sure our clients have enough cash set aside so that they can meet all their obligations so that we're not having to sell at a bad time if the market does go down. And we're always doing research, even in peace times, if you will, on types of investments we would want to own. So we try to know a bunch of different situations and then we just wait for the right price. So we would react to a recession by buying at the lower prices that tend to be served up by a recession. So, I'm surprised we don't have one, just like everybody else going into this year, but who knows if we'll get one anytime soon.- Well, and we all turn into armchair economists too during times like this. And I mean, you know, we exchange, we've got a good text string with our friend Joe Dylla. We exchange headlines that we see as indicators of maybe the Fed has gone far enough and maybe the Fed hasn't gone quite far enough yet. What did we see the other day? We were joking about the people paying $4,000 to get their daughters in the right sorority?- Right.- So maybe Mr. Powell and the other chairman have a little bit further to go.- Yeah, anytime I see something crazy like that, you know, last year, two years ago, it was all the crypto schemes and so, you know, I just kept saying over and over,"We just need higher rates." You just get such weird outcomes in markets in the economy with rates at zero. I mean, especially as long as it lasted. So yeah, the $4,000 sorority consultants tell me we might not be done with raising rates, and so-- Still a little ways to go-- maybe keep going. Still a ways to go.- All right, so given everything that happened starting in 2020, we're basically, you know, we told everybody to stay home and then threw trillions of dollars into the economy, is it safe to say we don't really have a playbook for what happens next?- Yeah, but I think that's true any time, any moment you're in the economy, you know? The saying is that history doesn't repeat, but it rhymes. And so I would say the moment that we're in right now, there are some times in the past that you had similar situations. So, coming out of World War II would be an example of something where there was an event, in that case it was World War II and this time it was COVID, where there's a lot of money printing and, like, but a lot of restricted access to goods and services and so on. And the year my dad was born in 1946, inflation started that year at 1% and it ended at like 13 or 14%, so-- Wow.- There are periods in the past where you had inflation picking up or you had low interest rates, but the situation's different this time too. So to that extent, there is no playbook exactly for this moment, you know? Rapid monetary policy, or monetary and fiscal reaction to a pandemic is not something that we've at least in our lifetimes had to deal with, but so again, you know, it goes just expecting the unexpected, being prepared, but also reading history so that you're not blown away by the moment, to realize that there are always times of being uncertain. That's always the thing that always kind of makes me cringe a little bit when I hear it, is that,"Aren't things really uncertain?" People always want to say that. You know, "Aren't things uncertain right now?" And I just always say that things are always uncertain. You know, times are always uncertain, and so to that extent, I don't really worry about the moment we're in or that there isn't some exact parallel to where we're sitting today.- [Adam] Sure.- You just have to study things and just always be prepared.- Yep. So from your chair, Kyle, what are you paying attention to in the near term?- Yeah, I would say as it relates to the economy, obviously we want to make sure that inflation keeps coming down, because inflation really is awful for a society, for an economy, and so it's in everyone's best interest that inflation comes down. And whether shopping at the grocery store or you've got all your money in US dollars or what have you, it's better for inflation not to exist at the present rates. And so we want to be paying attention to make sure that comes down. But as usual, the best part about my job is that the prices are changing every day on stocks and on bonds, and so we just pay very close attention to areas of stress. You know, one example might be REITs or real estate investment trusts. You know, office buildings. Those types of stocks are down 80-plus percent. So anytime prices are down a lot like that, that's where we kind of roll up our sleeves and dig in a little bit. So we're paying attention there. In bonds, we're looking at a lot of opportunities in mortgage-backed securities, bank CDs, things like that that we think are interesting. So there's always something to do in markets, and that's the, frankly the thing I like the most about it, is that that's the opportunity, is the prices are constantly changing and you know that the underlying values of the stocks that you're looking at aren't as volatile as the prices are. And so if you can keep your wits about you as you're looking at stocks in particular, there's going to be times where there's a lot of money to be made.- Sure.- And so we spend a lot of our time as an investment team doing the research well in advance and when it comes time to purchase so that we're, you know, in March of 2020, we sort of know what to do. You don't want to start your research process in March of 2020.- [Adam] Right.- And so that's kind of where we're at right now with stocks. There really isn't too much to do. No matter how you look at it, the stock market looks pretty pricey, and so we're not buying hand over fist like we would be in tough times.- Sure.- So.- Well, this cycle, like all economic cycles, does present some opportunities for people. So, I think we'll leave with this question. Who would be someone who would benefit from where we're at in the market right now, and what are some of those opportunities you're looking at?- I would say for particularly our older clients, they've been starved for income for a long, long time. You know, people that have done the right thing their whole lives. They've saved money and they're sitting on a nice nest egg and they're conservative. They're not invested in the stock market. Well, those folks have seen their income go up significantly. And so we're seeing a lot of opportunities for our clients to invest in certain types of bonds, to lock in these five to 6% interest rates, and so we've been busy with that. And on the stock market side of things, what I would say is that for our younger clients to not be nervous about the stock market. Even though we think it looks expensive, we think that just this process of always buying, whether it's in your 401[k] or money that you're saving every month and investing it, just to not interrupt that process by any worries that you might have about the election or the economy. So I would say that although we've spent a lot of time today talking about the economy, that really shouldn't factor in to the way that you would invest. And certainly we would never let any of our opinions about where we thought the economy was headed or who was going to be elected change how or when we are investing our clients' money. So, I think stay the course, be patient, expect difficult times to come at some point. That mental framework will serve investors well in the future because it's always served investors well in the past.- Yeah. You know, there's another segment that has been interesting, you and I've been talking a lot about recently. You know, we work with a lot of people that have liquidity events, and we've worked with a lot of families that have sold meaningful businesses. And a few years ago the options were, well, you can get almost nothing if you keep the money safe or you put it in the stock market, and maybe that felt a little bit like gambling to some people who were used to investing in their business and investing in themselves. But now with these liquidity events, they're able to deploy those assets in a pretty safe manner and still get a really, really nice return, and that has gone over really, really well with those families as well.- Yeah, that's a good point. So what we've done with those folks that have a liquidity event, they've sold a business, they've inherited a big chunk of money, the way we've approached that is to think of the money in terms of two different buckets. And in the one bucket, we'd call it the safe bucket, and that's where we're going to put our cash, our treasury bills, our municipal bonds that pay tax exempt interest. That type of stuff is awesome to buy right now, right? It's not that it can't get more awesome or that the yields can't keep going up, but able to get five, six, sometimes 7% return on that money in the safe bucket, and that's great. That means that you can live comfortably on income and so forth. And then with the, we call it the legacy bucket or the riskier bucket, which is stocks, what we've said there is that mathematically, you're better off investing it all at once, and that's because 70% of the time the stock market's up. And so given that set of odds, the smart thing to do is just invest it all. But we call it the regret minimization approach, is to spread out those purchases over time, and that's what we've done with those folks, is that we've taken the eyedropper out and we're just slowly investing the money over a long period of time. That way if the market goes up, which it's done this year, great. I had some money put to work in the stock market, whereas you might've been inclined to just wait. On the other hand, the stock market goes down, that's awesome too because I've got a lot of cash deployed into stocks. And so that approach seems to have worked and resonated pretty well with our clients.- Final question for you. When your boys go to college, do you plan to hire a consultant to help them get in the right fraternity?- That's a great question and the answer is no, first of all, let me say no upfront. Second of all, if they ever even asked me, I'd be shocked, you know, because they know dad to be pretty we'll say frugal.- Frugal.- However you want to define that.- We'll be generous.- Yeah, frugal, say frugal.- Yeah, we'll be generous and call you frugal. Thanks for being here today, Kyle.- Yeah, you bet.- Yeah.[upbeat music] I hope you found this helpful. If you did, please subscribe and share with your family or friends. If you have a topic you want us to cover in future episodes, send us a note through our website, and if you're at the point where you want an expert opinion on your finances, reach out and we'd be happy to start a conversation. And remember, any comments, insights, or strategies discussed on this podcast are intended to be general in nature and therefore may not be suitable for you and your situation, whatever that may be. Before acting on anything we discuss, please consult with your attorney, CPA, and/or your financial advisor.