While pundits argue about where we are in the economic cycle, there’s no denying that a recession will come eventually.
Bull markets don’t die of old age but many tell-tale signs of a recession are there. From rising rates to a tight labor market, the question in the market isn’t "if" but "when" will the next market crash occur.
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But how many have been proven wrong on their calls for an end to the historic bull charge? How many analysts and pundits have called for the next crash over the last decade…and how many have been right?
Will 2019 Bring The Next Stock Market Meltdown?
Economists are at odds with when the next recession might hit with many calling for a downturn in 2019 or 2020.
All the usual suspects for economic indicators have been blinking yellow lately. The Federal Reserve has been raising rates since December 2015 and is set to breach the neutral rate -- the rate at which its thought policy will start weighing on the economy -- sometime mid-2019. Unemployment is at multi-decade lows and wages are finally starting to creep up, threatening corporate profitability.
The recession probability indicator developed by JP Morgan now puts odds of the next downturn at 60% in the next two years.
Besides a worrisome economic picture, a study of forward returns when stock valuations reach current levels has investors fearful of hard times ahead. Analysts at Vanguard expect inflation-adjusted returns of just 3% annually over the next decade. For its part, Schwab expects inflation-adjusted returns to be slightly better at 4.3% annually through 2027 but still well below returns over the last decade.
A Smarter Strategy To Timing The Recession
As other investors rush to safety, trying to time the next recession, the smarter strategy may be to position now for the next economic rebound.
Recessions are an important reset on business. A downturn in spending and business activity removes the inefficient producers in the economy. The last decade has been historic in its ultra-accommodative monetary policy and interest rates that have allowed even the most inefficient companies to borrow and stay in business.
That means the shakeout of competition could be even more violent than usual in the next recession. The market leaders, those positioned to survive, will be able to pick up market share and run with it through the next cycle of economic growth.
Consider positioning in companies with market leadership and high marks for management stewardship, preferably in otherwise fragmented industries with lots of smaller players.
Albemarle Corp (NYSE: ALB) is the world’s largest lithium miner and, along with SQM, one of the lowest-cost producers. The price for lithium, used mainly in batteries, has more than doubled over the past two years and should continue to rise as electric vehicles and energy storage on other alt-energy resources become the norm.
The company has secured an agreement with the Chilean government to increase production in a region known for low-cost extraction. Analysts at Morgan Stanley have warned that the supply increase could weigh on prices but it could also shake out high-cost producers in Australia and other regions.
Albemarle controls roughly a third of the lithium carbonate market and benefits from double-digit annual demand growth, primarily from electric vehicles. The company has a solid balance sheet with $641 million in cash and $1.4 billion in long-term debt. The company returned more than $390 million, about 3.6% of the market cap, to investors last year through a buyback and dividend.
AutoZone (NYSE: AZO) is a leader in the after-market DIY auto repair space with an estimated 14% share in a relatively fragmented market of retail competitors.
While the rest of the market enters correction territory, the auto industry is already in a bear market with the First Trust Nasdaq Global Auto ETF (NYSE: CARZ) down 26% from its January peak.
Auto sales have come down from the heady post-recession promotions and higher rates have made loans more expensive. Shares of AutoZone have managed to buck the trend, rising 31% over the last year, as consumers switch to keeping their older cars running rather than buying new.
Strong growth in Brazil and Mexico has boosted earnings which are expected to rise 15% over the next four quarters. The company produced over $1.5 billion in free cash flow last year, more than 7% of market capitalization, which it returned to investors through a share repurchase program.
Roper Technologies (NYSE: ROP) is a diversified industrial equipment producer in four segments: RF & Software (41% of 2017 Sales), Medical Equipment (30%), Industrial Technologies (17%) and Energy Equipment (12%).
The industrials sector was hit especially hard in the October selloff with the Industrial Select Sector SPDR ETF (NYSE: XLI) falling 11% from its September high. Roper has been able to use its acquisition model to maintain sales growth, reporting a 13% year-over-year increase in the third quarter, and the shares have continued to rise.
The company’s business strategy has been to acquire technology in niche markets with a dominant share of the market. In RF Technology, one of its largest products, the company estimates it controls two-thirds of the market share for freight brokerage spot market in trucking. Roper’s Verathon segment makes several medical equipment technologies that dominate their market, including nearly 50% of the market for portable scanning equipment.
The company backed off on acquisitions last year, spending only $154 million versus $3.7 billion in 2016, and paid off over $1 billion in debt. This strengthened the balance sheet and could help it improve margins even as peers struggle against potentially weaker demand in a recession.
Risks To Consider: Even best-of-breed companies will get hit in an eventual recession though they should be able to bounce back quickly.
Action To Take: Position now for an eventual recession and the companies that should be able to take advantage of the shake-out to increase market share.