What is a Recession? Here's What You Need to Know.
The Fed is mired in a fight with inflation, and it looks like inflation has been more persistent than originally predicted. When the pandemic hit, lockdowns abruptly slowed down the economy. To combat the slowdown, the Fed lowered rates to 0% with the goal of encouraging spending. This action hurt savers because their interest rate on savings went to almost nothing. Coupled with massive stimulus, the economy now has too many people wanting to spend on goods that are in limited supply.
One of the main tools to combat inflation is to raise interest rates which should encourage saving and bring down spending. Now, by raising rates, the goal is to reduce spending and increase saving. The Fed is trying to do the opposite of what it did in 2020. The risk here is the Fed slows down spending too much and we experience a recession. Changing interest rates typically has a lagging effect on the economy and it’s hard to gauge if the Fed has gone too far, or not far enough, until it is too late.
When the topic of recession is brought up, some of the first things that come to mind are people losing their homes, losing their jobs, unable to pay their expenses or all the above. The term invokes fear, which the financial media is good at. The global economy has survived severe and sometimes mild recessions. The global economy will survive the next one and the one after that.
The definition of a recession is two consecutive quarters of negative GDP. Recessions can be major or sometimes minor. Neither is fun to live through but is generally healthy for a growing economy. Down markets tend to shake out speculation and give investors a chance to reset.
The two recessions in 2001 and 2009 still haunt people because they were both bad in their own way. And the media (fueled by the big investment firms with tall shiny buildings in New York) knows that and loves to pull these heartstrings when they post-dramatic predictions about the market.
In 2001, well-diversified portfolios did ok. If you were part of the water cooler investing club and you put all your money in dotcom investments, you may have lost it all. But the best place to be was cash, and we never recommend cash because cash is not an investment strategy. Cash rarely wins over the long term because it requires every other asset class to return negative. Negative returns tend to be short-lived so using cash as an asset class typically serves as a drag to a long-term portfolio most of the time.
In 2009, the housing market collapsed and nearly brought down the financial industry with it. The Great Recession was the longest recession since World War II. Diversification still worked, in the sense that the market fell, broadly, and the market recovered, broadly. But with every asset class negative, there were few winners to point to at that time. Building back a broken financial system was a stubbornly difficult and slow process.
Did you know we had a recession in 2020? The global economy locked down to “flatten the curve”. The Covid Pandemic was the shortest recession in history, lasting only six months. If you looked at your 2020 calendar year performance, you probably wondered why your portfolio was so disconnected from what you were reading. That year, the market moved up nearly 50% from its March lows. And that’s just the thing, we must be prepared to accept short-term volatility in pursuit of long-term growth. 50% from the bottom is impressive but the best days were right after the worst days. In just two days in March, the market recovered 12%. In just five days in April, the market recovered another 10%. Nearly half of the 2020 recovery occurred over the course of just seven days. Read that last sentence again.
Utilizing cash as a timing strategy is notoriously difficult and missing the best days has such a negative impact on long-term performance. (see chart below) Risk and volatility is the price investors have to pay for returns. Trying to sidestep market movements with market timing only creates more work and stress, and almost always results in a lower rate of return compared to investing all at once.
Image Source: Russell Investments
Even professional market timers pay that price. A study of professionals (or at least people who found a big enough audience to consider themselves “professional”) found that 61% of them failed to provide accurate market timing more than 50% of the time. Basically, the majority of market-timers are better off flipping a coin.
Looking back at history, no recession was exactly the same length or intensity. The Fed we know now came from rule changes that started in 1933 and 1935 and have continued to evolve since then. The Great Depression also created FDIC insurance. Financial stability was greatly improved, though still not perfect. The 1960s and 1970s suffered from high inflation and the tools the Fed used then were ineffective. As a result, the Fed started its dual mandate of employment and inflation, along with the tools to help the financial industry.
Recessions are scary because so many bad memories were borne from them. There are ways to lessen some of the pain which helps us focus on what we can control.
1) Ignore the noise.
This is much easier said than done. Even if you successfully dodged the barrage of headlines from the media, you’ll get it from your friends, family, and coworkers. It’s something to talk about other than the weather. It will come up in casual conversation. Have a canned response and move on. If you decide to engage, try to be open-minded about other viewpoints. Just know that none of it will change the outcome of your financial goals or where the global economy is headed.
2) Consider your source.
If you are reading financial news, whose job is to increase the number of readers, their headlines will be attention-grabbing and provocative. Everyone has a bias. If you’re reading this, that means the title of this post was exciting enough for you to click. Yes, I will admit we used the “R” word (recession), but our intent with all of this is to arm you with knowledge and facts so that the most dramatic headlines, those ones with the big crash predictions, just bounce right off you. Our job is to keep our clients invested because we can’t time the market. No one can. We have a long-term bias and view any sell-off as an opportunity to add to your position. In uncertain times, we will do what we can to keep you focused on the long-term because it has been historically the right course of action.
3) Reaffirm your risk tolerance.
If you reassessed your risk tolerance after losing 25%, the exact wrong thing would be to blow out of stocks and shift to bonds. That’s a planning fail, and potentially a life-altering move. We can’t let that happen. Zoom out and focus on the long term. Remember why you selected your portfolio allocation when you started. Getting more conservative after a 25% or 35% fall in stocks may be the worst thing you could do to your plan. Assuming you are well-diversified, you have the greatest likelihood of recovering when things settle down. Remember, markets don’t settle down, they settle up.
4) Make sure your cash needs are set.
Good financial planning, whether through a professional or DIY, will establish cash needs. Having a cash buffer all the time is advised because no one knows what life throws at us. Workers still get laid off in good markets, water heaters break for no reason, tires go flat, kids want to go to expensive camps. The point is, not having to sell assets at the wrong time is key. It is important to note that this is cash for expenses. Cash in investment accounts should not stay as cash in large amounts.
5) Know that market moves are random.
There will be upward bounces in down markets, only to continue down. Forecasters will say the market is now at the bottom, only to be early. The market will fully recover even when there are still doubts about the economy. None of the movements may make sense in the moment, and they don’t have to. Market participants will trade based on their needs or outlooks and their reasons are their own. Sometimes there are more sellers than buyers, which will push a market down even when there isn’t any substantial news. The market will move regardless of the media. The media reports on movement on the markets, the markets don’t tend to move based on what the media reports.
6) Reduce discretionary spending.
Do an audit of any subscriptions or memberships that have gone unused or aren’t necessary. Try to avoid using high-interest credit cards, even if you pay off the balance. Job security may be an issue, so carrying any kind of balance that can’t be paid off could lead to high-interest payments.
7) Try not to sell risk assets.
Most investors who sell in down markets do one of two things. They sell near the bottom after so much of the pain was already experienced, and they miss the rebound. Market history shows that rebounds are most powerful right after the bottom. No one knows where the exact bottom will be and anyone who said they “called it” is lucky or lying (or both).
Image Source: Visual Capitalist
8) Stay invested.
Through your personal investing history, the expansionary periods will far outweigh the recessionary periods. Going back to the 1950s, there have been only nine “dip” buying opportunities. If fear is driving investment decisions, the thing to fear the most is missing out. In other words, do nothing. The tendency to tweak your portfolio during a sell-off is heightened because it feels like you’re doing something. Most likely, you’re doing something harmful and you don’t realize it. This reminds me of a barbeque I went to and the grill master would constantly flip the meat. To all you grill masters out there, seeing this will probably drive you nuts. To get the best meat, you flip only once and let the meat rest after cooking. Barbequing yields better results when you do less.
Disclosures
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
