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Should my investment strategy change during a recession?

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Canada may have entered a “technical recession,” but that is not a reason for your investment strategy to change.

The relationship between economic data and stock returns is much messier than most people realize for a simple but counterintuitive reason: the stock market prices assets throughout the trading day based on expectations about the future, while news about economic data is backward looking.

A technical recession is defined as a drop in real gross domestic product (GDP) in at least two consecutive quarters. It is worth mentioning that this is not the formal definition of an economic recession.

The C.D. Howe Institute Business Cycle Council, the arbiter of business cycle dates in Canada, defines a recession as a “pronounced, pervasive and persistent decline in aggregate economic activity, typically resulting in a cumulative decline over adjacent quarters.”

Definitional nuances aside, investors tend to worry when they hear the word, “recession.” The concern is overstated, though not completely unfounded. Some historical recessions have been associated with major declines in the stock market, but recessions do not guarantee poor stock returns.

Of the seven economic recessions going back to 1957, three of them had negative stock returns, while the remaining four had positive ones.

Even if I could tell you the exact start and end dates of the next recession, you would not be able to reliably profit from the information. Of course, the fact that I can’t tell you the timing of recessions makes timing the stock market on account of an expected recession that much harder.

Importantly for investors, the three-year and five-year returns after economic peaks – that is, the peak immediately preceding recessions – have been meaningfully positive. Even if the market does decline in a recession, it has tended to bounce back.

Additionally, these are only Canadian data. When Canadian stocks perform poorly during a Canadian recession, there is a good chance that other countries or regions will deliver positive returns. For example, in two of the three historical recessions where the TSX experienced negative stock returns, the S&P 500 delivered positive ones.

While tempting, trying to time the stock market on expectations of a recession has been far from a slam dunk historically, even if you know when the recession will happen.

The relationship between future economic activity and stock returns was studied in depth by Eugene Fama and Kenneth French in a 2019 paper where they used yield curve inversions – which do forecast economic activity with some reliability – to time exposure to the stock market.

The two economists implement a market-timing strategy that shifts out of equities and into treasuries when yield curves invert. Based on the analysis, Mr. Fama and Mr. French conclude that they “find no evidence that yield curve inversions can help investors avoid poor stock returns.”

This is not a surprising result. Even the most successful economic forecasts do not reliably predict stock returns because those same forecasts are reflected in current stock prices.

Big shifts in stock prices tend to happen when the market’s prior expectations turn out to be materially different from reality. But there is no reliable way to predict future information and how that will match up with current expectations.

The result is a messy relationship between the economy and the stock market, and an important takeaway for investors: Trouble in the economy does not necessarily mean that your investments should change course.


Benjamin Felix is a portfolio manager and head of research at PWL Capital. He co-hosts the Rational Reminder podcast and has a YouTube channel. He is a CFP® professional and a CFA® charterholder.

 

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Investment

Tesla shares soar more than 14% as Trump win is seen boosting Elon Musk’s electric vehicle company

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NEW YORK (AP) — Shares of Tesla soared Wednesday as investors bet that the electric vehicle maker and its CEO Elon Musk will benefit from Donald Trump’s return to the White House.

Tesla stands to make significant gains under a Trump administration with the threat of diminished subsidies for alternative energy and electric vehicles doing the most harm to smaller competitors. Trump’s plans for extensive tariffs on Chinese imports make it less likely that Chinese EVs will be sold in bulk in the U.S. anytime soon.

“Tesla has the scale and scope that is unmatched,” said Wedbush analyst Dan Ives, in a note to investors. “This dynamic could give Musk and Tesla a clear competitive advantage in a non-EV subsidy environment, coupled by likely higher China tariffs that would continue to push away cheaper Chinese EV players.”

Tesla shares jumped 14.8% Wednesday while shares of rival electric vehicle makers tumbled. Nio, based in Shanghai, fell 5.3%. Shares of electric truck maker Rivian dropped 8.3% and Lucid Group fell 5.3%.

Tesla dominates sales of electric vehicles in the U.S, with 48.9% in market share through the middle of 2024, according to the U.S. Energy Information Administration.

Subsidies for clean energy are part of the Inflation Reduction Act, signed into law by President Joe Biden in 2022. It included tax credits for manufacturing, along with tax credits for consumers of electric vehicles.

Musk was one of Trump’s biggest donors, spending at least $119 million mobilizing Trump’s supporters to back the Republican nominee. He also pledged to give away $1 million a day to voters signing a petition for his political action committee.

In some ways, it has been a rocky year for Tesla, with sales and profit declining through the first half of the year. Profit did rise 17.3% in the third quarter.

The U.S. opened an investigation into the company’s “Full Self-Driving” system after reports of crashes in low-visibility conditions, including one that killed a pedestrian. The investigation covers roughly 2.4 million Teslas from the 2016 through 2024 model years.

And investors sent company shares tumbling last month after Tesla unveiled its long-awaited robotaxi at a Hollywood studio Thursday night, seeing not much progress at Tesla on autonomous vehicles while other companies have been making notable progress.

Tesla began selling the software, which is called “Full Self-Driving,” nine years ago. But there are doubts about its reliability.

The stock is now showing a 16.1% gain for the year after rising the past two days.

The Canadian Press. All rights reserved.

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S&P/TSX composite up more than 100 points, U.S. stock markets mixed

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TORONTO – Canada’s main stock index was up more than 100 points in late-morning trading, helped by strength in base metal and utility stocks, while U.S. stock markets were mixed.

The S&P/TSX composite index was up 103.40 points at 24,542.48.

In New York, the Dow Jones industrial average was up 192.31 points at 42,932.73. The S&P 500 index was up 7.14 points at 5,822.40, while the Nasdaq composite was down 9.03 points at 18,306.56.

The Canadian dollar traded for 72.61 cents US compared with 72.44 cents US on Tuesday.

The November crude oil contract was down 71 cents at US$69.87 per barrel and the November natural gas contract was down eight cents at US$2.42 per mmBTU.

The December gold contract was up US$7.20 at US$2,686.10 an ounce and the December copper contract was up a penny at US$4.35 a pound.

This report by The Canadian Press was first published Oct. 16, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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S&P/TSX up more than 200 points, U.S. markets also higher

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TORONTO – Canada’s main stock index was up more than 200 points in late-morning trading, while U.S. stock markets were also headed higher.

The S&P/TSX composite index was up 205.86 points at 24,508.12.

In New York, the Dow Jones industrial average was up 336.62 points at 42,790.74. The S&P 500 index was up 34.19 points at 5,814.24, while the Nasdaq composite was up 60.27 points at 18.342.32.

The Canadian dollar traded for 72.61 cents US compared with 72.71 cents US on Thursday.

The November crude oil contract was down 15 cents at US$75.70 per barrel and the November natural gas contract was down two cents at US$2.65 per mmBTU.

The December gold contract was down US$29.60 at US$2,668.90 an ounce and the December copper contract was up four cents at US$4.47 a pound.

This report by The Canadian Press was first published Oct. 11, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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