Is a Recession Coming? Or Will We Party Like It's 1999?
By Jeffrey Schulze, CFA, Investment Strategist, ClearBridge Investments
Is a recession coming? History can be a good guide. Examining the signals from the late 1990s and early 2000s, when a recession hit, can help investors evaluate the many similarities – and differences – between then and now.
There are many parallels between today and late 1998: a 19% stock market correction, quick recovery and a brief inversion of the yield curve. The 1998 pullback proved to be a great buying opportunity, as the economy and markets marched higher into the new decade. In 1999, investors were partying.
Then came a recession, in the early 2000s, as the dot-com bubble suddenly burst.
Today’s market lacks the overvaluation and cyclical excesses of those times. Equities hit all-time highs again in April, with stocks making up all their lost ground from the 19.8% drawdown in late 2018. Yet the large magnitude of this non-recessionary correction, and its swift rebound, is a reminder of the market hiccups during the summer of 1998.
Stresses from the Asian Financial Crisis found their way to U.S. shores, and the S&P 500 Index fell 19.3% from July 17 to August 31. The turmoil led to the near blowup of hedge fund manager Long Term Capital Management (LTCM) in September, avoided only when the U.S. Federal Reserve (Fed) stepped in to facilitate a $3.6 billion backstop from 14 banks and brokerage firms.
With the economy and financial markets on wobbly footing, the yield curve briefly inverted in September 1998. The Fed responded by reversing course and cutting interest rates by 50 basis points (0.5%). Ultimately, economic and market volatility subsided, and markets marched higher: The S&P 500 achieved a new all-time high by November 1998, just two months after LTCM was saved.
There are other parallels between then and now. In both times, the market sold off sharply, the yield curve briefly inverted, and the market recovered strongly; along the way, U.S. equity markets hit new all-time highs and a recession was avoided. We are in an elongated economic cycle – and technology stocks again lead the markets.
There are several key differences to 1998-2002 – chiefly a lack of market overvaluation, cyclical excesses and an economy running too hot – that led to the dot-com recession. This should bode well for further market and economic upside in this cycle.
The technology bubble’s collapse led to the recession in the early 2000s. Like many bubbles, the early stages of the dot-com bubble were somewhat well-grounded. In the mid/late 1990s, the Internet grew rapidly and began to be commercialized. Some of the early companies went public, leading many others to try to follow. Capital flowed in as investors chased the early successes.
Then everyone lost sight of the fundamentals. Business managers became overconfident and overspent. As the most speculative internet companies went belly-up, their overly optimistic expectations eventually crashed.
Cracks began to emerge in the economy too, with key indicators such as wage growth flashing warning signs in June 1999. Ultimately, the economy entered a recession in March 2001. The S&P 500 bottomed in October 2002, 49.2% below its peak roughly 2.5 years earlier.
And today? Broad economic data came in above expectations in March 2019, with U.S. GDP growing at an annualized 3.2%. While volatile inventories and trade boosted this figure, these strong reports should help continue to allay investor concern from the recent market volatility.
Jeffrey Schulze, CFA
About Legg Mason, Inc.
Guided by a mission of Investing to Improve Lives™, Legg Mason helps investors globally achieve better financial outcomes by expanding choice across investment strategies, vehicles and investor access through independent investment managers with diverse expertise in equity, fixed income, alternative and liquidity investments. Legg Mason’s assets under management are $747 billion as of Jan. 31, 2019. To learn more, visit our web site, our newsroom, or follow us on LinkedIn, Twitter, or Facebook.
Jeffrey Schulze is an Investment Strategist at ClearBridge Investments, a subsidiary of Legg Mason. His opinions are not meant to be viewed as investment advice or a solicitation for investment.
©2019 Legg Mason Investor Services, LLC, member FINRA, SIPC. Legg Mason Investor Services, LLC is a subsidiary of Legg Mason, Inc.
All investments involve risk, including loss of principal. Equity securities are subject to price fluctuation and possible loss of principal. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors. Additional risks may include those risks associated with investing in foreign securities. Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.