These are two questions I hear a lot and I hear myself asking these two questions. Conventional wisdom is that if we are heading into a recession, you don’t want to own stocks. I’ve never found that statement to be true though as I’ve made a lot of money for myself and clients in recessionary environments. This time though could be different. Normally a recession triggers Fed rate cuts. As interest rates are one of the biggest determinants of relative value, lower rates makes for higher stock valuations.
With rates near zero, though, this thesis might not hold. After all interest rates can’t really go lower in any meaningful way. Don’t expect big interest cuts by the Fed. It’s impossible with rates near zero. They can only go so low. That leaves the other hat to hang on. Are stocks undervalued? Ironically both questions are tied at the hip and are central tenants of the discounted cash flow method of valuing stocks. This is the very technique that Warren Buffett uses to value a stock or company
Based on discounted cash flow and certain assumptions like a 2% 10 year risk free rate of return, a great many dividend paying blue chip stocks are dramatically undervalued. This is also assuming we are not growing at all but are in a recession indeed. We’ll publish the list of grossly undervalued blue chips in the next day or so so stay tuned.