Recessions Are Part of a Normal Economic Cycle

Key Takeaways:

  • Recessions and bear markets are part of a healthy economic and financial market cycle.
  • The best we can do is allocate accordingly.
  • Inverted yield curves occur in most recessions—but they don’t necessarily mean a recession is imminent.
  • Stocks generally decline leading up to a recession but tend to rise as the recession wears on.

 

As the old saying goes, “economists have successfully predicted eight out of the last two recessions,” and this week’s news cycle seems to support the old economic joke.

The financial headlines are ripe with warnings about the “imminent” recession and its potential effect on the stock market. It’s long been argued that no one can reliably predict when the next recession or bear market will occur, let alone how long those dreaded events will last or how severe they will be. We know that recessions and bear markets are part of a normal economic cycle. The best we can do is allocate our portfolios accordingly, evaluate our risk in relation to our overall financial plan, and ignore the headlines that will ultimately proclaim, “this time is different!

I recently attended an eye-opening presentation by Liz Ann Sonders, Senior Vice President and Chief Investment Strategist for Charles Schwab. As always, Liz did an outstanding job of evaluating the economy and key financial indicators, while providing a realistic take on what all the data and related noise meant. Granted, Liz’s comments about the current economic expansion were more guarded this year than in the past, but she wasn’t all gloom and doom.

Liz highlighted some facts about the market:

  1. The current economic expansion is the second longest we’ve had since World War II – but it’s also our weakest expansion.
  2. We just experienced an inverted yield curve for the first time since mid-2007, a situation in which interest rates on long-term debt drop below interest rates on short-term debt, which could indicate a lack of confidence in the economic outlook.
  3. Almost all recessions have included an “inverted yield curve,” but an inverted yield curve does not necessarily mean a recession is coming.
  4. Since World War II, we have experienced 18 bear (or near bear) markets and nine recessions. A bear market is generally defined as a 20-percent decline in the stock market over at least a two-month time frame. On average, bear markets fully recover within 12 to 15 months of when they start.
  5. Generally speaking, the stock market declines prior to the start of the recession and actually rises over the course of the recession.
  6. Some, but not all, indicators predict a slowing economy. On the positive side, employment and wages are trending upward and the Federal Reserve is slowing the pace on interest rate hikes.

What does this all mean?

Even the best and brightest minds can’t predict the direction of the economy and the financial markets. There are too many forces at work to know what the future holds. I firmly believe in economic development and in the power of ingenuity. Thus, investors will be richly rewarded for holding stocks over the long-term. However, this may be a good time to evaluate your portfolio and consider the following:

  1. Your risk level: Is your portfolio’s risk appropriate considering your age and your proximity to retirement (if you’re not already retired)? Do you have enough cash, bonds, or CD’s to sustain your standard of living during a bear market?
  2. Your asset allocation: If you have been aggressively allocated for some time or have let your portfolio ride for the last few years, it might be a good time to rebalance.
  1. Your diversification: Make sure you are properly diversified. Large-cap stocks have been on a tear the last several years. However, you should include other dimensions of the market in your portfolio, such as small-cap stocks, value stocks, and international stocks. These holdings may help you reduce volatility and potentially increase returns over the next several years. A recent example is the “lost decade” of 2000-2009 when the S&P 500 had 10 years of negative returns, while a globally diversified portfolio achieved positive returns over the same period.
  1. Your stomach: Realize that bear markets and recessions are inevitable. When they happen, ignore the headlines and stick to your well-thought-out investment plan. You’ll sleep better and have less indigestion.

We Can Help You Find a Plan

No matter how rough the seas are during a storm, they eventually calm down. If you or someone close to you has concerns about the viability of their investment plan, especially in relation to their overall financial plan, please don’t hesitate to contact me. I’m happy to help.

 

Todd Flynn, CPA, CFP® is a Principal at Soundmark Wealth Management. Todd works closely with physicians, business owners, and other successful and accomplished individuals to help them define their financial goals and implement an ongoing financial planning process.