Are We Headed for a Recession?
We’re just two years removed from the last US recession. Negative stock returns and aggressive US Federal Reserve interest rate hikes have many investors concerned we are headed for another big “R”—if we’re not already there.
But recessions are always identified with a lag. By the time one is called, the worst of its impact on markets has usually passed.
The National Bureau of Economic Research (NBER) identifies business cycle phases using a bevy of indicators, such as consumption and income data, employment rates, and gross domestic product growth.
None of these measures has been consistently dominant in determining economic conditions, and past US recessions have come in all shapes and sizes. Recessions are therefore named retroactively, with the benefit of hindsight (and additional economic data that may be available with a lag).
Because recession proclamations are delayed rather than in real time, markets are often on the way toward recovery by the time of the announcement.
As shown in Exhibit 1, the stock market had already bottomed out before the announcement month in two-thirds of recessions since 1980.
In 2020’s recession, for example, the market’s low point came in March, three months before the announcement in June 2020.
Exhibit 1 Fret Lag Recession announcements vs. US stock market lows
Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
The takeaway for investors?
If and when a recession is declared, we think the most sensible approach is to remain disciplined with one’s asset allocation; reducing exposure to stocks at that point may lead to missing out on brighter days ahead.
I know it is never easy to see your account values go down. Still, we must remember these pullbacks are temporary, and attempting to time the market by cashing out adds great risk and uncertainty to your financial plan as you may miss the right time to get back in.
Always keep a long-term perspective. Just look at these indicators of market performance for the first half of this year, compared to 2019, 2020, and 2021 alongside the long-term 20-year total returns annualized of each investment index:
Capturing these types of long-term positive returns is based on your “time-in-the-market” and not trying to “time-the-market,” and 2020 was a perfect example of this. While we don’t have a crystal ball and cannot predict the short-term direction of the stock market, we know the best outcomes are achieved through proper planning and preparation.
Recessions are a natural part of our business cycle. Since 2000, the United States has experienced three major recessions, all horrible at the time, but we persevered.
Those who stayed invested from 01/01/2000 – 06/30/2022 would have been rewarded with a Russell 3000 Index (entire US Stock Market) return of 6.51% total annualized return. Said another way, $250,000 would be worth $1,033,896 even after this latest downturn.
With that being said, this is why we recommend the utilization of diversified funds instead of high concentrations in individual stocks. During recessions, companies will go under. Losses in individual stocks may never come back to pre-recession valuations. New companies will emerge that will make previous industry leaders obsolete (think Netflix vs. Blockbuster). Prudent diversification and ensuring you are not over-concentrated in any single company or sector helps reduce the risk of losing it all. Again, look at the 20-year returns of the indexes above and then think about how many companies you used to love 20 years ago no longer exist today!
For those who are not comfortable with the full stock market volatility, there are ways to reduce the extreme highs and lows with negatively correlated alternative asset classes & investments. This is the essence of diversification!
Julie Manning, RICP, CFF
President & Advisor
Keystone Financial Planning
*2022 AND 20 YEAR TOTAL RETURN AS OF 06/30/2022.
**PERFORMANCE & RETURNS FROM KWANTI PORTFOLIO ANALYTICS.
***YOU CANNOT INVEST DIRECTLY IN AN INDEX. THE CLOSEST INVESTMENT TO AN INDEX CAN BE DERIVED FROM AN INDEX FUND.