2023-06-06 07:10:00 ET
Summary
- The economic data points to a recession starting in Q3. In fact, some data says we're in a recession already.
- The Federal Reserve's interest rate hikes could lead to $1 trillion in loan losses by the end of the year.
- Earnings estimates will likely fall significantly in the coming months, potentially creating a 20% to 30% decline in stock prices.
- The world's highest-quality companies have battle-tested management teams and strong balance sheets to help you ride out the coming economic hurricane.
- Here are two of the highest quality companies you can buy right now, to help you sleep well at night in the coming market mayhem, and profit from the new bull market that is likely to begin by the end of the year.
This article was published on Dividend Kings on Monday, June 5th.
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If you're not confused by the market or economy right now, you're not paying attention.
On Friday, we had another blowout jobs report , the 14th consecutive month when new job creation beat expectations.
- 339K vs. 195K consensus.
The previous two months were revised up as well, and the 3-month rolling average for job creation is now 288K.
- 3.5 million annualized rate.
However, unemployment, which is based on a household survey instead of from companies, reported unemployment rose 440K from 3.4% to 3.7%.
So, jobs possibly rose 339K or fell 440K.
In the 1973 recession, job growth was positive for eight consecutive months after the recession began.
The economist consensus is that the recession begins in Q3 (as early as July). Thus, it might not be until May of 2024 that we see negative job growth (though probably before that).
The productivity data points to a potential recession already underway.
Labor productivity fell 2.1% in the first quarter from the fourth at an annual rate and was down 0.8% in the first quarter from a year earlier, the Labor Department said Thursday. That is the fifth-straight quarter of negative year-over-year productivity growth-the longest such run since records began in 1948. " - WSJ (emphasis added).
In fact, one measure of output, gross domestic income or GDI, says we're possibly in a recession already.
That would certainly explain the productivity decline since productivity is output/number of hours worked.
The more jobs created in a contracting economy, the worse the productivity numbers will be.
It's "not that technology got worse in the last year, but that businesses were selling less stuff, and they're nervous about their ability to attract employees, so they're holding on to their employees," said Jason Furman, an economist at Harvard University who served in the Obama administration." - WSJ.
In other words, labor hoarding in the face of falling sales could explain the productivity data.
Why should anyone care if the economy actually falls into recession if, as the Wall Street Journal says, we're in a "full employment recession"?
Two main reasons.
First long-term growth is driven by labor force growth rate (0.2% for the U.S.) + productivity growth (currently -2.1%).
More importantly, in the short-term, is the fact that wage growth - productivity growth = inflation.
- 4.2% wage growth - (-2.1% productivity) = 6.3% inflation.
In other words, if today's productivity growth were to remain, inflation would actually rise from 4.9% to 6.3%, and the Fed would be forced to hike rates to 7+%.
The Fed tracks several kinds of inflation metrics, which are way above the Fed's 2% long-term target.
Based on the data, the Fed tracks interest rates should be much higher.
Or, to put it another way, the economy is almost too strong not to force the Fed to hike us into recession.
Why This Time Likely Isn't Different
The stock market's rally off October lows is largely driven by one narrative, the "soft landing." That means no recession, falling inflation, and strong earnings growth.
- S&P earnings growth in 2022: +5%
- +2% EPS growth consensus in 2023
- +12% in 2024
- +12% in 2025.
Bottom-up analyst estimates are not expecting an earnings recession despite having had three consecutive quarters of negative EPS growth so far.
The Fed is expected to cool inflation quickly, cut rates next year, and keep the economy and earnings growth humming along.
The trouble is that inflation has never been above 5% in U.S. history without the Fed having to hike us into recession.
Is it impossible? No, it would simply be unprecedented.
If the economy doesn't fall into recession, then inflation likely stays stuck at levels far above target, and the Fed has to hike us into recession.
How is it possible that we can fall into recession if we're creating jobs (maybe) at a rate of 3.8 million per year?
Here Come The Loan Losses The Fed Has Been Trying To Create
The Fed hiking rates 5% in 14 months is designed to increase borrowing costs, tighten financial conditions, and kill off weaker "zombie" companies.
Deutsche Bank analysts pointed to the boom in credit that spanned the past two decades, with financial institutions ramping up lending as markets enjoyed ultra-low interest rates and steady economic growth.
But that era is coming to an end with tighter lending standards and higher interest rates. The onslaught of defaults appears to have already started, with US high-yield bond defaults rising to 2.1% from 1.1% last year and loan defaults rising to 3.1% from 1.4% last year.
At their peak, high-yield bond defaults could rise to 9%. Meanwhile, US loan defaults could rise to 11.3%. That's close to the all-time high of 12% seen during the Great Financial Crisis, though the overall credit bust will likely be less severe than 2008, the bank forecasted." - Business Insider (emphasis added).
The Fed wants to see loan losses rise, bank lending pull back, and consumer spending decline to decrease demand and cool inflation.
Loan default rates have doubled since the Fed began hiking, and Deutsche Bank thinks they will nearly quadruple from here.
"Our cycle indicators signal a default wave is imminent. The tightest Fed and ECB policy in 15 years is colliding with high leverage built upon stretched margins," analysts said, calling defaults a "near-term risk" over the next six to 12 months." - Business Insider.
Bank of America thinks that the peak default rate won't be as bad as Deutsche Bank's estimate.
We think it is reasonable to argue that that the next-3yr default cycle, whenever it starts, should add up to a lower peak," he said. That would still amount to an 8% corporate default rate in a full-blown recession, which could translate into $920 billion of corporate debt defaults ." - Business Insider (emphasis added).
Almost $1 trillion in corporate defaults might sound terrifying, but it's actually a lot better outcome than the worst-case scenario.
It has been a long time since we had a proper credit cycle," Oleg Melentyev wrote to clients on Friday, pointing to the credit cycles beginning in 1981, 2000, and 2007. Those cycles were upended by a dramatic tightening of credit conditions, leading the three-year default rate on US corporate default debt to soar to around 15%.
Melentyev said that a 15% default rate on corporate debt was a "distinct risk" as the US approaches a recession and credit gets tighter, though he believed a coming credit crunch would likely be less severe than what was seen during the Great Financial Crisis." - Business Insider.
This kind of debt super-cycle could lead to $2 trillion in defaults, but Bank of America thinks it will only be half that bad.
And as if all that wasn't bad enough, we can't forget the major effects of the debt ceiling that was raised on Saturday.
On Monday, June 5th, Treasury will sell $170 billion worth of 3 and 6-month T-bills to start restocking its general account.
- $500 to $600 billion in bond sales by the end of June
- $1 trillion by the end of September
- $1.5 trillion by the end of the year
This is a very big liquidity drain," says Panigirtzoglou (JPMorgan strategist). "We have rarely seen something like that. It's only in severe crashes like the Lehman crisis where you see something like that contraction."
Citi and JPMorgan expect the S&P 500 (SP500) to fall 5% to 6% in the next few weeks purely due to the Treasury's massive bond sales.
Historically speaking, after we get a $500+ billion liquidity shock within five months, stocks have fallen a median of 10%.
And now it's happening when we're likely headed into a recession.
According to the bond market, and NY Fed, the risk of recession is the highest it's been in 42 years.
We're facing a perfect storm of risks that the stock market has priced out completely.
Perfect Storm For Stocks Might Be Coming Soon
Piper Sandler has the lowest S&P price target on Wall Street, but given the rising risks, it's worth knowing their model.
Piper Sandler's Kantrowitz is calling for a recession later this year and for the S&P 500 to shed 22% of its value and fall to 3,225 by the end of 2023." - Business Insider .
Historically, stocks bottom at 13 to 15X through earnings outside of a financial crisis.
He also said 12-month forward earnings estimates for the S&P 500 would drop by 15% from $245 to $215 by the end of 2023, which informs his 3,225 calls. Earnings estimates are already starting to dip negative as the economy slows. Historically, that has meant a recession has already begun or is about to start." - Business Insider.
I feel like a weather man who's coming out at the end of May and saying, 'In December, it's going to be cold.' And people walking outside their house right now, and it's 80 degrees, and they're like, 'What are you nuts?'" Kantrowitz said." - Business Insider.
Bank of America also expects a sharp contraction in earnings of 16%, and Morgan Stanley thinks a 20% EPS contraction is coming.
Morgan Stanley's Mike Wilson has a year-end target of 3,900 but still sees a drop to somewhere between 3,000-3,300 in the meantime. Wilson was the most accurate forecaster among major strategists in 2022." - Business Insider.
According to Institutional Investor, the most accurate economist of the last 42 years is Ed Hyam of Evercore ISI.
He expects a 1.5% GDP recession to begin in July, the last nine months, and push unemployment to 5.2%.
Oxford Economics thinks the new debt ceiling deal will make the coming recession a bit worse, though not have much of a lasting long-term impact.
Anyone who thinks a recession is coming but that stocks have already priced it in on October has all of history working against them.
The triumph of hope over experience." - Samuel Johnson.
May was a bad month for stocks unless you owned tech. Want to know where the recession is in the stock market? Everything other than tech.
That doesn't mean a crash is guaranteed, and it most certainly doesn't mean that market timing is the answer.
Market Timing Doesn't Work
Economic Timing Doesn't Work
Bear Markets Are Wonderful
This is why it's so important to own companies that you can count on in the bad times.
In a recession when loan defaults are soaring, corporate bankruptcies create scary headlines, and stock prices can fall as much as 10% in a day, you must own the world's best companies.
That's how you ride out the market hurricane to reach the glorious new bull market on the other side.
The Ultimate World-Beater Blue-Chip Bargains To Buy Now
The Dividend Kings uses a 3,000-point safety and quality model that includes over 1,000 metrics to estimate safety and overall company quality.
When faced with a likely looming recession caused by historic Fed tightening and one of the largest liquidity shocks in history from the U.S. treasury, it's prudent to trust your hard-earned savings to the strongest and safest companies.
So here are the two highest quality world-beater blue-chips you can safely buy going into the 2023 recession and likely coming market correction.
Mastercard: As Close To God's Own Dividend Stock As Exists On Wall Street
Further Reading
Why Mastercard Incorporated (MA) is A Potentially Good Buy Right Now
Mastercard is an A+ rated 100% quality Ultra SWAN with some of the best margins on earth.
The company has $7.6 billion in cash and $15.6 billion in liquidity and is generating $1 billion per month in free cash flow.
It is a pure toll road for credit and debit card transactions, with no credit risk.
Summary Facts
- DK quality rating: 100% very low risk 13/13 Ultra SWAN (sleep-well-at-night)
- Fair value: $425.81
- Current price: $373.73
- Historical discount: 12%
- DK rating: potential good buy
- Yield: 0.6%
- Severe Recession Cut Risk: 1%
- Long-term growth consensus: 19.7%
- Long-term total return potential: 20.3%.
Mastercard tends to be recession resistant. During the Pandemic, global lockdowns on travel hurt its international cash transfer business, but in 2009 its earnings grew 18%.
In other words, Mastercard's business is normally very resilient, even during periods of economic weakness.
Lowe's: As Close To God's Own Dividend Aristocrat As Exists On Wall Street
Further Reading
Why Lowe's Companies, Inc. (LOW) is A Potentially Good Buy Right Now
Lowe's is a 63-year dividend growth streak dividend king and the highest quality Dividend aristocrat you can buy today.
Based on management guidance, LOW has already priced in a recession, with analysts expecting a 3% decline this year.
- management guidance is for flat growth
- so LOW has the ability to beat expectations.
LOW has been buying back stock at a prodigious rate in the past year.
- $14 billion in 2022
- $8.5 billion consensus in 2023
- $8.1 billion in 2024.
In other words, LOW has the ability to boost EPS by 6% to 7% per year through 2024 through buybacks alone.
Combined with an all-star executive team poached from Wall Street's best and brightest, you have the makings of an extremely dependable dividend aristocrat that can be counted on to provide steady income growth as well as strong medium-term and long-term returns.
Summary Facts
- DK quality rating: 100% very low risk 13/13 Ultra SWAN (sleep-well-at-night)
- Fair value: $267.79
- Current price: $209.81
- Historical discount: 22%
- DK rating: potential Strong Buy
- Yield: 2.1%
- Severe Recession Cut Risk: 1%
- Long-term growth consensus: 19.8%
- Long-term total return potential: 21.9%.
Bottom Line: The Ultimate World-Beater Blue Chips Can Help You Sleep Well At Night In The Coming Market Storm
Let me be clear: I'm NOT calling the bottom in MA and LOW (I'm not a market-timer).
Even Ultra SWANs and aristocrats can fall hard and fast in a bear market.
Fundamentals are all that determine safety and quality, and my recommendations.
- over 30+ years, 97% of stock returns are a function of pure fundamentals, not luck
- in the short term; luck is 25X as powerful as fundamentals
- in the long term, fundamentals are 33X as powerful as luck.
While I can't predict the market in the short term, here's what I can tell you about MA and LOW.
These are two of the highest-quality world-beater blue-chips on earth.
They have strong balance sheets and brilliant and battle-tested management teams and have proven they can be trusted in recessions.
While it's always possible that this will be a soft landing, the first in history when inflation is this high, the economic data and history are not on the side of the short-term bulls.
But that doesn't mean that selling everything and hiding in cash is the answer.
History is very clear that market timing is not the answer to a recessionary bear market.
Trusting the world's greatest companies is the easiest and lowest-risk road to riches you can travel.
And right now, Mastercard and Lowe's are the highest quality and safest dividend stocks you can buy ahead of the likely economic hurricane that is bearing down on us right now.
Wall Street has always been a game of probabilities, never certainties. But I can say with 80% confidence that anyone buying MA or LOW today is going to be very happy they did in 5+ years.
For further details see:
The Ultimate World-Beater Blue-Chip Buys Right Now