Eddy Elfenbein submits: Talk of a soft landing is very in right now. It's the new uber-cool. No wait...I think it might even be the new black. Actually, I'm not really sure. Either way, it's here, get used to it. Even Jeremy Seigel has jumped on the Soft Landing Bandwagon.
This got us to thinking, how has the market behaved during previous soft landings? The problem is, true soft landings have been quite rare. Many landings start out soft, and become hard very fast.
By my count, there have been three successful soft landings of the past 40 years. The first was in 1966, then again in 1986, and again in 1995. Here's a graph of the 10-year Treasury yield along with the 90-day yield going back to the early 1960s:
As always, I pass the graphics savings on to you the customer.
The 1966 case is probably the most relevant to us today. The country was at war. It was a mid-term election year. Short-term interest rates had been climbing for some time, and the yield curve flattened out in January in 1966. Short-term rates continued to head higher and didn’t peak until September.
Remarkably, the economy wobbled but didn’t go under. Real GDP grew by 4.3% in 1966, 2.5% in 1967 (including a flat second quarter) and ramped up to 4.9% in 1968. It wasn’t until late-1969 that the economy finally started to break.
The stock market, however, had a painful time in 1966. Stocks peaked on February 9, shortly after the 90-day yield first caught up with the 10-year yield. At its high point, the Dow came within 5 points of 1,000, although it wouldn’t close above the millennium mark for another six years. By the low point on October 9, the Dow lost 25% and the S&P 500 dropped 22%.
This was a classic bear market. I think the outlook for stocks is far better today than it was 40 years ago. P/E ratios have been coming down, and the Fed is already talking about calling off its rate increases.
Starting from January 10, 1966 (roughly when the yield curve first became flat) and measuring one year out, the best industry groups were Hardware (18.9%), Books (17.3%), Gold (15.2%) and Insurance (7.85). The worst were Health (-66.2%), Software (-39.3%), Textiles (28.8%) and Chemicals (23.4%).
In 1986, it was still Morning in America, although real GDP growth had been dropping from its blistering levels. The economy grew by 5.6% in 1984 and 4.3% in 1985. By 1986, the economy grew by just 2.8% (1.4% in the second quarter) and a recession seemed possible. Once again, it was a mid-term election year. Just like 1966, the party controlling the White House was rebuked at the polls.
The slowdown, however, was temporary and the economy accelerated again. In 1987, the economy expanded by 4.5%. Despite the market crash, the economy grew by another 3.7% in 1988.
The major difference between now and then is that the yield curve never got anywhere close to inverting. Long-term bond holders were still not convinced that Paul Volcker had won the war against inflation. The top-performing groups of 1986 had a definite defensive bias; Tobacco (50.5%), Drugs (35.7%) and Boxes (35.4%--really, that’s what it says "Boxes"). The worst groups were Health (-15.1%), Hardware (-8.6%) and Aerospace/Defense (-7%). It’s interesting to see that Hardware went from best to worst, but Health is still at the bottom.
In 1994, the Federal Reserve had raised interest rates very aggressively. By 1995, the economy began to feel the squeeze. Real GDP growth was just 2%, less than half the rate of the year before. The economy was particularly weak in the first half of 1995 when it by 1.1% in the first quarter, and 0.7% in the second quarter. Since long-term yields climbed with short-term rates, the yield curve never formally inverted.
All ten S&P 500 sectors had a good year in 1995:
I think history shows that defensive stocks are a good place to ride out a soft landing. You're protecting yourself against the most severe losses, and there's a good chance for decent capital gains.