How Will a Recession Affect Me and What Can I Do to Minimize Its Effects?

When the word recession starts to circulate, this can strike fear and panic into businesses and investors alike. Why the fear and increased interest? Because when there is a slowdown in economic activity, people tend to start spending less (businesses don’t like this) and businesses slow down their investment, which impacts supply and demand. Type “recession” into Google Trends and you’ll discover that searches for the term peaked during the weeks of June 12 and July 24, which, perhaps unsurprisingly, happened to coincide with the Fed’s meeting and subsequent interest-rate increases during those months.

What defines a recession?

In July of this year, it was reported that the U.S. economy shrank in the second quarter by 0.9%. This was the second consecutive quarter where the economy contracted, and while two consecutive quarters of negative growth is often considered a recession, it's not an official definition. That is determined by the National Bureau of Economic Research (NBER), a nonpartisan committee made up of eight economists. Several factors go into the calculation that determines whether the NBER officially declares a recession. For instance, at the time of the data release, around 400,000 jobs a month were being created, which is historically good for the U.S. economy. Undoubtedly, though, the economics had weakened with inflation trends running hot combined with interest and mortgage rate increases. But we are not “officially” in a recession . . . yet.

Even if we do eventually find ourselves in a recession, while it may feel unnerving, it is, in fact, part of a natural economic cycle and happens more often than you think. Since 1948 (the first after World War II), there have been eleven recessions in the U.S. On average, this is every six years. When the NBER does declare a recession, its definition is a significant decline in economic activity that is spread across the economy and that lasts more than a few months. The length of time can vary significantly and determines the long-term impact. Prior to the Global Financial Crisis in 2008–09, which lasted eighteen months, the average length was less than a year and, in fact, the most recent in 2020, because of the COVID pandemic, lasted just two months. For longer-term investors (i.e., time horizons of 10+ years), the shorter the recession, the less long-term impact.

What are the chances of a recession?

The Federal Reserve (Fed) has consistently raised its target interest rate over the course of 2022, which hit its four-decade high in March. The Fed appears to be continuing to raise rates as a means to potentially reduce inflation, which could dampen economic growth and lead to a recession.

A recession may be a necessary trade-off to potentially bring inflation down, but which will also see economic output fall and increases in unemployment. Raising interest rates and keeping economic growth positive is the major challenge the Fed faces. Here are three reasons adding to the chances of a recession:

1.?????Inflation has been rising for some time now

While in the past we have seen higher rates of inflation, after a long period of low inflation and low rates, prices are comparatively high across consumer goods and unemployment is low. This could lead to wages rising, further pushing up prices and pressure on inflation. Wage increases could accelerate significantly, which, in turn, could lead to further price increases and continued inflation so the Fed will continue with their rate-increase strategy

2.?????Interest rate policy is not having the desired effect so far

There is a lag between rate changes and economic impact and the temptation is to keep raising rates, which could have damaging effects, as was the case in the 1980s and 1990s. Consumer confidence plays a role insofar as rising rates and associated costs lead to a cut back on spending

3.?????The global dynamic

It’s not just here in the U.S. Interest rates are set to rise around the world in response to inflation, and as a result, global trade will weaken after having been hit by the pandemic. Additionally, this year the war in Ukraine is contributing to a rise in commodity and energy prices, which reduces real incomes and spending around the world.

What changes, if any, should I make to my portfolio?

Whether you make any changes to your portfolio depends on your individual situation and goals, including how your portfolio is currently positioned and your time horizon. What may work for other investors may not work for you.

When it comes to your portfolio, if you are well-diversified, small adjustments and rebalancing may be appropriate. Since your portfolio is allocated according to your risk tolerance, over time this can get out of balance. In a recession, volatility can increase, exacerbating any imbalance, and bringing your portfolio back to its correct balance is something you can control. Some asset classes also tend to perform better during economic downturns than others, therefore minor adjustments to your portfolio to incorporate them can help improve diversification, thereby reducing the risk.

Your time horizon also plays an important role. For instance, if you’re in your 30s or 40s and saving for retirement, the short-term volatility experienced during a recession will not have a lasting impact on your portfolio since the longer-term horizon increases the likelihood of recovering any lost value once that volatile period has passed. Historically, for younger investors, a recession can also be a good time to add to their portfolio, depending on their risk tolerance and affordability. In the two years after a recession since 1948, for instance, the S&P 500 Index has positive returns 82% of the time at an average return of 20%.*

For those nearing retirement, however, short-term volatility can have a bigger impact on those plans. A wealth preservation strategy may make more sense by moving into less volatile investments, such as cash and money markets, as well as diversifying into investment opportunities less correlated with the broader market, such as some alternative investments.

Creating an investment strategy can be incredibly complicated at the best of times, but it is important not to make rash decisions based on fear. And fear can be hard to resist when the word “recession” starts trending online and continually appears in hyperbolic news headlines. If it feels overwhelming and you are concerned about making emotional decisions, an advisor can provide you with objective, valuable advice that can help you understand how a recession would impact you and what steps, if any, you may need to take as a result.

*Cumulative price return of S&P 500 during past recessions. Source YCharts, Nber.

DISCLOSURES:

This information is presented for educational purposes only and is not intended to constitute investment advice. This presentation should not be relied on for investment recommendations. You should consult with your financial advisor to thoroughly review all information and consider all ramifications before implementing any transactions and/or strategies concerning your finances.?Any investment strategy involves the risk of loss of capital. Past performance is no guarantee of future results.

?Although the information contained in this report is from sources deemed to be reliable, Morton Wealth makes no representation as to the adequacy, accuracy or completeness of such information and it has accepted the information without further verification. No warranty is given as to the accuracy or completeness of such information.