Don’t Discard your Strategy During a Recession
We own stocks for a very deliberate reason. These equities are inflation resistant, generate cash, and the good companies grow at a rate faster than the economy they are a part of. They change prices wildly in a recession as people try to determine the long-term value of those features, but at the end of a recession, it is the only asset class that will be worth more after the economic slowdown.
Stock prices might be down, but that doesn’t mean you need to change the way you invest. Remember you own these assets for a reason. This thought process applies to both long-term and short-term investors, and retirees.
Long Term investors have the most to gain from a recession. It is very likely younger investors have been buying stocks at historically high prices. Any investor that began building their portfolio after 2001 has only had three windows where the broad market was trading below its historical average. That’s right, with the exception of three small windows in the last 20 years investors have been “overpaying” for their exposure to the market. Long-term investors might see the next window opening before their eyes right now.
If you place most of your money in stocks, don’t “chase performance” and sell out of them. They may be falling in price while bonds are rising in price. Don’t chase bonds, don’t chase life insurance schemes, and don’t try to buy and sell rapidly. Don’t change what you are buying for the long term, in favor of what you see in the short term. Take advantage of the discount in prices – and keep saving.
Short-Term Investors and Retirees
Although you may be uncomfortable during a bear market, don’t be tempted to sell your stocks or stock mutual funds at a loss across the board. Make two things a priority, lower your risk, and focus on cash flow.
This is a time to focus on quality investments, and pair down the speculative portions of the portfolio – this isn’t the market for moonshots. Begin by accepting that speculative bets might be lost forever and start looking for investments that will survive economic contraction.
If you need income right away, it would be best to have money set aside in cash and bonds before the downturn. That way, you can withdraw from your cash while you wait for stock prices to recover. Then look for investments that can safely replace the cash you need on an annual basis – bonds, real estate, and dividend stalwarts are the keys here. If you can create a cash balance, then you can keep your more speculative investments grinding through the economic slowdown.
Ideally, if you are retired, you and your CFP® know what your annual need for cash is, and what investments and institutions are working to replace that cash as fast as it is used.
Investing Before and During a Recession
It’s easy to go wrong during a recession if you forget or don’t understand how certain investments perform during a downturn. Or how they are related to each other.
The stock market is a forward-looking vehicle. Stocks represent your right to a company’s future cash flows. So when warning signs of a recession “hit” these are the most skittish assets and will react the most violently. This doesn’t necessarily mean these companies won’t survive the recession or even become better as a result. What it means is that the amount that other people are willing to pay for a company’s future earnings is lower. When the recession becomes a thing of the past, people will begin to overpay for earnings again, and this is where you want to be in a position to sell shares to those people.
Stock prices often fall months before a recession begins, which also means that they often bounce back up before the recession is declared over. You can miss an entire downturn if you only follow the news. That is why it is vital to know the signs of a recession and recovery, and how assets perform during those periods.
These are our general expectations of asset behavior during a recession:
Stocks: Prices for stocks tend to fall before the downturn begins, often selling off even at the scent of a recession. Stocks are the most volatile and skittish, during a recession. But they also have the most to gain. Good companies buy back their own stock during a recession, smart investors buy more shares at lower prices, and recessions make good companies leaner, and more financially fit for the next business cycle.
Real Estate: After stocks, Real Estate is the second most appetizing asset in a recession. And for some, it might be the most appropriate risk. Real Estate investors get the luxury of not having the mark-to-market value of their portfolio put in front of their face. During a recession, they make known their real estate is “down” but they are rarely bombarded with the daily and hourly reminders of the real estate market. This does two things, it reinforces patience for the investor and shifts their focus to the income the property produces. Both of these are things we noted above that stock investors need to learn in a recession.
Bonds: Prices for bonds tend to rise during a recession which means their yield declines. Good bonds (that is to say Bond from good companies) will often be over pursued their security – leading to an opportunity to sell overpriced bonds to scared or unprepared investors. Historically, The Federal Reserve (the Fed) stimulates the economy by lowering interest rates and purchasing Treasury bonds. But for the coming recession, this may not be the expectation as the Fed is in the first innings of raising its rates. This might be the macroeconomic element that causes this recession to be different than those in the past.
Cash/deposit accounts: Since interest rates fall from the Fed’s actions, they tend to do so on deposit accounts as well. However, cash and insured accounts are free from market risk, unlike bonds and stocks. People use cash for “safety” but usually lose buying power to inflation for however long the recession persists.
Gold: Most investors call gold a “haven trade”. This has been historically accurate, Gold outperforms for the short period of time when the recession is darkest. But it also loses its gains quickly when the all-clear on the recession is called. So, for those dealing in gold, they are usually too slow to effectively capture the gains.
The Bottom Line
Financial markets are the single most efficient way of transferring money from the national and global markets to cash in your bank account. Recessions are by their definition a period in which the speed of that transfer slows down, not stops. So those that accumulate assets up to and through a slow down reap the benefits when the pace of that flow speed back up.
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