Recessions are a common occurrence in the economic cycle. Right now all of the metrics are stating that we are headed towards a recession. The question is not if we are headed towards a recession, it should be more about how deep the recession may be. Here are five things you need to know about recessions.
1. What Is A Recession: A recession is defined as two consecutive quarters of decline in GDP (Gross Domestic Product). We currently had two consecutive quarters of the negative GDP, however, that has been offset by a positive GDP number recently. In a normal recession, you are likely to see lagging real incomes, lower employment, and lower retail sales. Traditionally, the lower spending on the discretionary side causes equity markets to move lower.
2. How Long Do Recessions Last: This is a question that is quite often asked by my clients. According to the National Bureau of Economics and Research 2, the last 11 cycles since 1950 shows that recessions have persisted between two and 18 months. Going back even further between 1921 and 2009, the average expansion has been 47 months and recessions have only lasted 14 months, according to JP Morgan's Guide to the Markets 3.
3. Recessions and The Stock Market- During recessions and bear markets, you can see the market fall more than 20%. One commonality coming out of a recession is that equities tend to bounce back quickly being that the market is a forward looking indicator. The stock market is a discounting mechanism, that generally foretells market dynamics within equity prices. The equity market will fall months ahead of a recession, and then move higher prior to the recession ending.
4. Recession Indicators: There are some significant indicators that warn us of an impending recession.
- First and foremost is the yield curve. The normal yield curve within government treasuries and bonds is upward sloping. When the yield curve starts to invert you begin to notice slowing in the economy. One sign a recession occurs when the 10 year yield falls below two-year yields. This typically shows you that investors are seeking safety and longer dated maturities.
- The unemployment rate generally moves higher. As you may know the current employment cycle has roughly 2 jobs per job seeker. This dynamic is uncommon, however, it does not mean that jobs will not be lost. You are already starting to see companies layoff and cut back their spending and staff.
- Housing starts is another warning sign. In general, when housing starts decline at least 10% from the previous year, that is a sign of an impending recession. When the economy is slow, and the economic outlook is unfavorable home builders will delay housing projects. According to Capital Group 4, when you see this, the average time until recession is 5.3 months.
- Another indicator is consumer confidence. If consumer confidence is declining from the previous year, it is generally a warning sign. When consumers are not optimistic about the economy, they tend not to spend. The US economy is roughly 70% consumption in regards to GDP.
5. What Should You Do To Prepare? Timing a recession is all but impossible, however, you can do these these things to prepare.
- Relax-Do not become overly involved in the news media on the everyday movements of the markets. The media is designed to gather eyeballs for advertising.
- Diversify- it has been time-tested, by maintaining a well-diversified portfolio, you may have a better chance of reaping the benefits of a rising market well before the recession has officially ended.
- Rebalancing-when the market sells off, there is an opportunity to rebalance your portfolio. By adjusting the weightings of different asset classes within the portfolio, you maintain your overall risk, target and investment objective.
There is a lot of media prognostication about if we are headed towards a recession, how deep will that recession be, and how to maintain your buying power in the face of rising inflation. The average investor may see this and consider getting out of risk based assets and go to cash, however, studies show that those who move to cash may miss out on gains months before the recession has ended, and furthermore, may lock-in losses due to selling at lows and inflation. Continually investing dollars over a long period of time and removing all of the noise still remains a key principle within investing. Contact your advisor and discuss your opportunities in this current market space.
Footnotes and Sources
Past performance is not a guarantee of future results. Indices are unmanaged and one cannot invest directly in an index. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest rate, issuer, credit and inflation risk. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Diversification does not guarantee profit or protect against market loss. Dollar Cost Averaging (DCA) does not assure a profit or protect against a loss in declining markets. DCA involves continuous investments over time regardless of fluctuating price levels. Investors should consider their ability to continue to invest in periods of low-price levels.
9I Capital Group LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.