Two Points From 2020’s Two-Month Recession

Yesterday, the National Bureau of Economic Research (NBER) announced that the recession accompanying last year’s lockdowns officially came to an end … in April 2020. That means the official arbiters of US recession dates have decided the recession ended two months before they declared it to be underway in June 2020. This illustrates two key—if simple—points for investors to bear in mind now and always. One, recession dating is far too lagging to be of any use when trying to identify bull and bear market turning points. Two, it is yet more evidence last year’s recession was too short and bizarre to qualify as a typical reset of the economic cycle, which we think explains why growth stocks have led during the recovery—and should keep doing so.

Let us rewind for a moment to last year. Western society started reacting to COVID with voluntary and involuntary limits on event attendance and overall economic activity in mid-to-late February. Stocks began falling at about the same time, peaking on February 12 globally and February 19 in the US. After a steep, weeks-long drop, they bottomed out on March 23. But we didn’t get the first hint of negative economic data until March 24, when flash purchasing managers’ indexes for March showed broad contraction. Over the next several weeks, monthly indicators flashed deep declines for March and April. But NBER didn’t make the recession official until June 8, when they declared activity had peaked in February 2020—something basically every data series in America had already demonstrated. As had stocks, which had endured an entire bear market before economic data began registering lockdowns’ damage.

Eight days after NBER’s press release hit the wires, the US Commerce Department announced retail sales had jumped in May. Other positive indicators began rolling in, showing broad recovery in May and June. But that nascent rebound wasn’t enough to erase all of April’s deep decline, so Q2 GDP still registered a significant contraction. However, the broad, reopening-related recovery started showing in Q3, and growth continued in Q4 and Q1 2021. GDP finished that quarter just -0.9% below Q4 2019’s peak.^[i] In a few days, we will see whether Q2 growth was strong enough to eclipse that, technically moving the economy out of recovery and into expansion. In other words, NBER waited until GDP was nearly at breakeven to declare the recession over. That isn’t a knock on NBER, which always deliberates over these things and announces turning points at a delay, once it is crystal clear a new trend is underway. But the fact that stocks began rising about a month and a half before we now know the economy began improving—and nearly three months before that improvement showed up in the data—demonstrates the market’s forward-looking prowess.

Now, we doubt investors sit around waiting for NBER declarations in order to make major portfolio shifts. But the temptation to wait for some sort of clarity on economic trends runs deep, raising the question: What counts as clarity? There is no air raid signal in markets. Nor is there an all clear. Every decision on whether to position for a bull or bear market relies to some degree on a thesis. To us, that thesis or theory should be based on interpretation of an array of signals, some of which may contradict each other. Success requires figuring out which indicators are most forward-looking, which are coincident and which are late-lagging—and how markets normally behave around turning points. Usually, by the time there is enough hard data to give you clarity, the moment when taking action might be beneficial has likely long-since passed. While 2020 was an extreme example, that holds true for more normal past recessions as well.

Yes, you read that last sentence right—last year’s recession wasn’t normal. We suspect society calls it a recession because there is no other word for a broad decline in economic activity. But garden-variety recessions generally start when overstretched, bloated businesses meet tightening credit, which usually stems from an inverted yield curve. When funding dries up, businesses slash investment and inventories in order to survive, and the pain ripples broadly as consumers—sensing bad times—cut discretionary spending. The recession continues as businesses shed unproductive assets, and it ends as the yield curve steepens, returning funding to companies that are now lean and mean. They achieve quick growth off the bottom through productivity gains, driving big earnings growth as recovering revenues meet cost cuts—benefiting value stocks most, as they generally have the hardest time staying afloat on the way down, setting a low bar to clear.

The depiction doesn’t hold this time. Businesses weren’t bloated when governments curtailed economic activity in February and March. Maybe there were patches of excess in green technology and similar niches, but froth wasn’t pervasive. Businesses didn’t have much fat to trim. Nor did the pain last long enough for them to need to do so. Fed assistance helped them bridge the short gap until economies reopened in spring and summer. Banks also continued lending broadly. Many small businesses didn’t survive, and that is tragic for the communities, owners and workers. But value stocks broadly didn’t have that traditional recessionary suffering, negating the steep bounce effect that usually occurs off the bottom. In our view, the cycle wasn’t drawn out enough to put their survival in doubt, contrary to the norm.

Because the growth/value cycle didn’t reset, we think stocks—like the broader economy—are acting like this is a late-stage expansion. GDP growth rates are already slowing, and companies didn’t make astronomical productivity gains last year. Inventories and business investment didn’t endure their usual deep, prolonged pounding. In our view, that points to an environment where most earnings growth comes from revenue growth, not cost cuts. Our research has long showed this benefits growth stocks most—companies with diverse product lines, global footprints, strong brand names and the ability to tap bond markets cheaply to finance expansion. Notwithstanding a few countertrends, growth has led cumulatively since last year’s bear market ended. Usually, once they take a baton late in the market cycle, they hold it for the duration, leading us to believe growth likely keeps dominating value for the foreseeable future.

Remember this when the next countertrend inevitably arises and pundits resume singing value’s praises. Remember it when data from Europe, which is reopening later than America, heats up and excites the value bulls again. Remember it the next time long-term interest rates creep up and create visions of roaring growth. We strongly suspect all those theses are widely known and baked into prices, leaving growth stocks as the underappreciated, unsung hero.