Every so often someone in an initial meeting or a client meeting will ask me if I think there is a recession coming. They are typically disappointed when I answer of course. Of course there is. It’s like the coming of the seasons, or an intermittent fast after thanksgiving. It’s natural and needed. This fascination with the future never ceases to amazing me.

I may have mentioned that this summer I re-read C.S. Lewis’s classic work The Screwtape Letters. In on of the chapters he talks at length about how productivity and good is stolen from us when we focus on the past or the future too much. Or worse yet, try to predict the future based on past events. I’ve met well meaning people who would say they know they cannot predict the future but yet give them a backward looking statistic and suddenly they are tempted to extrapolate that into a future event. The information age or “manipulation age” as I like to call it, being what it is, our algorithms start fetching us information which confirms our theories. If we are not careful we are listening to people who are less than reputable because we have invested our time and intellectual capital into a process that we are too proud to give up. My grandmother used to joke when we asked her how she was feeling that her headstone would one day read: “I told you all I was sick!” I remember this every time I read of someone forecasting the end of the world or the end order or the next “meltdown”. It’s like looking at someone and saying who is having a good time and saying “you are stretching yourself too thin. Eventually you are going to catch the flu or a cold and die.”

Sure, all the pieces of information listed above could technically be true. But are they helpful? Are they even connected? Sure they could be. But more probably, they are not. Many people do this same thing when they focus on trying to ascertain when the next big market event is going to happen. These investors have settled on a paradigm of being a participator and timer of events rather than an owner. They view the market as if it were a bus that they can get on or off at will. In this analogy the bus due to breakdown and they try to time their decisions by guessing how long to stay on that buss.

Now if they were a part owner of the bus, I have to believe that their focus would be different. Rather than focusing on things that could not be predicted, I have to believe they would focus on the things which under their control and which are knowable. IE the miles on the bus since it’s last service and etc. As an owner you ask different questions than if you are simply riding along.

As I write this the S&P 500 is currently trading at a multiple of 22 times forward earnings. The 30 year average is 17 times earnings. Additionally, as of the end of the 2nd quarter this year the top ten companies in the S&P made up of 38% percent of the weight by market capitalization and 32% of the earnings. I won’t belabor this but you don’t have to analyze the situation too long before you start to realize that certain sectors and portions of the market are expensive.

The person simply riding the bus asks questions like: how much long will this last? Will it go higher? How can I get out before it goes down? Etc. All incredibly unhelpful and potentially harmful questions.

The owner asks: what is my exposure to those expensive companies? Do I need to rebalance? Do I need to trim my exposure? Do I need to exit those positions and reallocate elsewhere? This theme of ownership vs participation is undervalued because very few people who are either entering retirement have gone through a period of market volatility which lasted a long time. Furthermore they didn’t have to convert their portfolio into cashflow during that period. Going through volatility whilst earning a paycheck vs going through volatility when your portfolio is producing your paycheck is a very different situation both structurally and emotionally. I joke with people that our society these past 10-15 years has become addicted to V-shaped recoveries and almost entitled to hedge fund like returns whilst paying index fund prices.

So while we cannot control when or even if the next recession will find us, we can prepare for how we respond to it. A better method of preparing for the inevitable is to take stock of what you own and what you are spending. Start by evaluating what percentage of your annual spending needs and trends are covered by dividends? This is a simple exercise and takes a few minutes of grabbing statements. An even better question is: what portion of the dividends paid in your portfolio are coming from companies who have a history of growing that dividend or simply not cutting that dividend? Is it 25% of your income need? 50% of your income need? 75%?

These questions avoid focusing on the price or value of your portfolio and instead focus on the production of it. Notice that this exercise doesn’t take the opinion of some economic oracle into consideration. This person, though right about 5 of the last 10 recessions doesn’t control your spending rate, your number of shares owned or the products and services offered which have pricing power in the marketplace.

When people send me an article which uses a salacious headline or fear tactics to gain traction I typically respond the same way. Who do you believe will have more functional staying power? A person trying to predict an event or the employees of well run companies? When you look at your portfolio I don’t want you to see stock prices, rather I want you to see products and services which are durable. I want you to see the initiative, creativity and sheer will of the employees behind those products and services. That is the formula which drives satisfied customers and the loyalty which finds its way to the bottom line of balance sheet and ultimately gets paid to you in the form of a dividend. If you must, picture the feet of million + people employed by the companies in your portfolio hitting the floor every morning seeking to better serve their customers and earn a profit. In a way you are capturing a portion of their creativity and ingenuity. The next time you are tempted to listen to someone waxing poetic about how the end is nigh. Ask yourself who you have more confidence in. This so called experts ability to be right or the creativity of your portfolio team to find their way through economic conditions good or bad?

I’ll leave things there for this week. But as we move forward please keep these keep these proactive questions in the back of your mind. Have a great week and please remember that we are wishing you and your family continued Truth, Beauty and Goodness ahead. Have a great week!

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