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Once a month I get together for a dinner with a few different hedge fund managers who cover a variety of strategies. Some have a long bias, some a short bias. Some are long debt, and so care about overall credit risk in the economy, while others make bets on huge volatility and catastrophe. The common thread among most managers is that everyone has a strong opinion about what the future holds, even though the reality is that none of us has a clue.
A big argument at these dinners is whether or not the economy is heading into recession. You have people who are convinced it is, because of adjustable rate mortgages (payments getting higher) and the demise of the housing boom. Others insist business will take over on spending now that it has more cash than ever and is under pressure to do something with it.
I say: so what if there is a recession? At least then it is over with. All sorts of good things come with a recession, such as the Fed lowering rates again, stocks getting cheap (in fact, many stocks in the last recession started trading below cash).
“But,” my friends always point out, “what about the stock market during a recession? I don’t think you want to ride through another 20 per cent drop.” Of course I don’t, but who says the market has to drop 20 per cent? I looked at all the 11 recessions since 1945 and examined how interest rates and the stock market behaved during these periods. Specifically, the periods I looked at were:
February, 1945 – October, 1945
November, 1948 – October, 1949
July 1953 – May, 1954
August 1957 – April, 1958
April 1960 – February 1961
December, 1969 – November, 1970
November, 1973 – March, 1975
January, 1980 – July 1980
July 1981 – November, 1982
July 1990, March, 1991
March, 2001 – November, 2001
First, I looked at interest rate yields on the 10-year note. Of the 11 postwar recessions, yields fell in 10 of them. The only recession where yields on the 10-year did not fall was from November 1973 to March 1975, when the yield on the 10-year went from about 6.7 per cent to 7.5 per cent. So far so good, I can use some lower yields.
The news is not as good when looking at the stock market but it is certainly not bad news either. Across the 11 recessions, the market has gone up during six of them (1945, 1953, 1960, 1980, 1981, 1990) and down during five (1948, 1957, 1969, 1973, and 2001). On average, the market was dead flat during recessions. I know 11 is not a significant example, and the volatility is quite large across the sample (the worst was a 22 per cent drawdown in the 1973 recession, and the best was the 21 per cent postwar bump during the 1945 recession). Still, I like to get the facts straight before getting flustered about a recession.
The next question to ask is: which stocks did best in the last recession?
For instance, there is Arkansas Best, which trades under the symbol ABFS. It transports food, textiles, apparel, furniture, chemicals, plastics, automotive parts and machinery, and provides various freight and transportation services. It was up 30 per cent during the 2001 recession from $17 to $23. Now it is near an all-time high at $44. That said, all the metrics look good now. Return on equity is a healthy 20 per cent, and at the moment it is trading at a meagre 4.2 times cash flows with earnings before interest, taxes, depreciation and amortisation at $225m and its enterprise value (market cap minus net cash) coming in at $963m.
Another excellent pick is J.C. Penney. During the 2001 recession, JCP went from $14 to $21, a 50 per cent return. Now it is exhibiting a 22 per cent return on equity, with a great balance sheet ($2.7bn in cash, $3.4bn in debt but Ebitda of $2bn – more than enough to pay down debt quickly if it so chooses) and at the moment it is trading for a 7.5 multiple of enterprise value over Ebitda, putting it squarely in leverage buy-out territory. The market is also undervaluing its highest growth asset: jcpenney.com.
It is important not to speculate too much on the unknowable or on areas where it is impossible to get an edge. Rather, seek out the facts and act accordingly.
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