By now, we’re desensitized enough to the word “recession” that the mention of it doesn’t send us into a tailspin. The current probability of a U.S. recession in the next 12 mos is 60% (according to a Bloomberg composite of estimates). That probability has risen steadily over the last six months, and as it stands, the S&P 500 is down 19% YTD and taxable U.S. bonds are down 16% YTD. Yuck.
But remember the typical order of events: the market falls first, then earnings get hit, and the economy bottoms last.
This week is one of the most, if not the most, important week of earnings season. So far, it hasn’t been great for large-cap technology companies, which are an important litmus test for the current and future tone of company guidance. The Q3 expectations for broad S&P earnings were already pretty low, somewhere between 3-4% year-over-year growth, and if we remove the Energy sector, growth would be negative. I expect further downward revisions and some notable misses this quarter and next, which is likely to challenge the market rally and bring corporate margins down.
Here’s the good news: that means we’ve started ticking the box on “earnings get hit.” As we move through that process, next up we’ll likely see the economy hit the skids in a bit more dramatic fashion than we’ve seen thus far. There are already several classic recession warning signs in place, and the risks that still lie ahead are bringing the likelihood of an actual recession closer into view. Note that a recession is not certain, and there is still a chance we avert one, but this article focuses on what to do if one does materialize.
As investors, we have two choices. We can run screaming into cash and cover our eyes until it’s over, or keep our wits about us and position our portfolios for the different market phases we may go through. I think it goes without saying, we should choose the latter.
Carving Out Opportunities
That brings me to the question: Which parts of the market tend to do better before, during, and after a recession? I’m taking a 30,000-foot view and listing broad asset classes, and the patterns here are clear. This table includes average performance over the periods outlined for all recessions back to 1926.
First, many might be a bit disenfranchised with bonds because it seems like they failed us horrendously as diversifiers in 2022. And they did. But that was coming off of a 40-year rally in the bond market and years of interest rate levels so low that bonds had nowhere to go but down once tightening began.
The so-called “re-rating” in both stock and bond valuations this year makes bonds again an attractive piece in your portfolio puzzle. Just take a look at the average returns for long-term corporate and long-term Treasury bonds during a recession, and compare those to the average returns for stocks. If you believe that a recession is coming in the next 6-12 months (I fall on the sooner-rather-than-later side of that coin), this is a time to build or add to high quality bond positions.
Second, it’s not about exiting the stock market. In fact, for long-term investors, it’s rarely about exiting. It’s more about where within stocks you want to put your money in order to avoid some of the downside, and participate in the upside when things recover. The table shows quite clearly that large-caps, typically thought of as more stable and steady, do better before and during recessions, but they’re left in the dust by small-caps after the recession ends.
Small-caps are generally riskier, more economically sensitive, and more volatile than large-caps, so it should be no surprise that they lead in early phases of economic expansion. The surprise usually comes from investors who didn’t have an allocation and miss that upside opportunity. It may feel uncomfortable, but before year-end, I believe it’s time to get a position in small-caps into your allocation. More specifically, I’d use a low-cost ETF, and preferably one that tracks the S&P 600 index since companies have to pass a profitability requirement for inclusion.
Lastly, something that’s not in the table, but is worth mentioning, is sector performance. This is another way to think about arranging your stock allocation, especially the large-cap portion. For the period heading into a recession, the best performing sectors tend to be Healthcare, Staples, and Utilities—classic defense. Whereas coming out of a recession, the strongest performers tend to be Materials, Discretionary, and Financials—classic economically-sensitive groups.
Abracadabra
This is in no way exhaustive of all the positioning options that are available for pre-, during, and post-recession, and there is no such thing as a magic potion. But one of my favorite quotes is “what got you here won’t get you there,” from Marshall Goldsmith. As 2023 draws near, and the time when we will finally answer the recession question also draws near (in my opinion), it’s important to heed the advice the market has given us in past recessions. If your portfolio doesn’t include some of the classic recession and post-recession plays, it’s time to throw them in the witch’s brew and stir.
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Your complete guide to surviving a recession
Recession warnings are everywhere. With interest rates rising, inflation hitting the highest levels in 40 years, and stocks plunging into bear market territory, most people are more than a little worried. Let’s face it, many of us are feeling the pain of the current economy every time we fill the tank, stock the fridge, or check our 401(k) balance.
But the reality is that, whether or not they fit the technical definition of a recession, these types of downturns are a normal (albeit painful) reality of economic cycles. When they happen, one of the most productive responses is to turn worry into action. Building a fortress around your finances can protect against tough times and put you in a better position when the economy bounces back.
So exactly what to do in a recession? These five steps can help you prepare for any type of economic slowdown, now and in the future.
Recommended: What is a Recession and Why Do They Happen?
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Dramatic price increases across the board have already forced many consumers to cut back on their budget for basic living expenses such as groceries and travel. Now is also a good time to review bank and credit card statements to find other cost-cutting opportunities.
Maybe those streaming services that were a lifeline during COVID aren’t necessary any more. Or, it might make sense to put off some of those home improvements you were considering, keeping the equity in your home intact should you need it during the slowdown.
Revamping your budget can help you handle today’s higher prices and also help free up a few dollars for steps 2 and 3 below.
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Hard as it may be to find extra cash right now, it’s important to make sure you are putting something aside for unexpected expenses. Don’t feel overwhelmed by the advice saying you should aim for three to six months’ worth of living expenses. Saving that much right now may sound more discouraging than helpful, especially for people who saw their emergency funds dwindle during the pandemic. Keep in mind, anything you can save (even $25 a month) is good, and even small weekly deposits add up over time. Whatever you can afford, know that it’s worthwhile to prioritize emergency funds.
With emergency savings, you may get to take advantage of one of the few benefits of rising interest rates. Savings accounts may begin to pay more interest soon. What kind of savings account should you get? You might look for high-interest accounts offered by online banks as they often pay more than bricks-and-mortar financial institutions. Your goal, of course, is to get the best rate. If you are employed full time, check with your benefits department to see if any emergency savings programs are available through your work. Having some cash in the bank can be a key step when you are wondering how to handle a recession. It can be a hugely helpful safety net.
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Here’s the bad news about higher interest rates. The national average credit card rate rose above 17% for the first time in more than two years, according to a recent weekly rate report. The jump happened after the Federal Reserve increased interest rates. More rate hikes are expected throughout the year.
Check rates on all of your credit cards and other debts. Any variable rates may have already gone up. Next step? Pay as much as you can on your highest interest rate balances first to whittle down that debt; it’s the kind that can unfortunately snowball during tough economic times.
You might also look into balance transfer credit card offers. They can offer a period of no or low interest, during which you can pay down that debt. Another option is finding out how debt consolidation programs work.
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The current economic turmoil hits just as federal student loan repayments are set to begin again in September, after a more than two-year reprieve during the COVID-19 pandemic. Another extension is expected (and hoped for by many) but has not been announced. Nonetheless, payments are likely to start again sometime.
If you’ve taken advantage of the pause, this is the time to get ready for repayment, whenever it comes. Contact the servicers of your federal student loans to make sure you know the monthly payment due date and other details that you may have forgotten or that may have changed during the pause.
If you’re worried about affording repayments, look into alternatives. Forbearance, for example, allows a qualified borrower to suspend federal student debt payments for a period of time, although interest continues to accrue. Government-sponsored income-driven repayment programs are another option. They cap monthly loan payments at a percentage of what is defined as discretionary income. Still other borrowers may find refinancing student loans through a private lender can be an affordable option. It can be worthwhile to do the research to find out what exactly your options are to stay current on your loans.
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When it comes to your long-term investments such as 401(k)s and other retirement accounts, the key to surviving a down market is simple: Hold tight. Nothing good is likely to happen when you sell in a panic. Not only do you risk selling at a loss, but you’ll miss out when the market rebounds, as it inevitably does.
Take a look at the most recent downturn. The Standard & Poor’s stock market index plunged almost 31% in March 2020 when Covid first hit. Then the index almost doubled just a year later. Investors who sold in a panic didn’t see any of those record-breaking returns.
If rising expenses are making it impossible for you to keep up with 401(k) contributions, you may want to try to deposit the minimum necessary to get any matching funds your employer offers. That’s free money, and you don’t want to miss out.
Also try to avoid making any withdrawals from your retirement accounts. In most cases, if you’re younger than 59 ½, you’ll pay a 10% penalty plus taxes.
Even more important, a chunk of your money won’t be there to see the growth in your long-term savings account when the market rebounds.
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Most recessions include high unemployment and mass layoffs. This slowdown is a little different. So far, the unusually strong labor market has protected the U.S. from rising unemployment, contributing to the one bright spot in the U.S. economy. Wages have also increased, but generally not enough to offset the current record inflation.
Economists warn the strong employment market may not last. That’s something to be ready for, especially if you work in an industry that typically suffers downturns in a recession. And employees who may be counting on finding a higher-paying position in this strong job market may find their window for doing so is closing. What’s more, in a worst-case scenario, some people could find themselves figuring out how to apply for unemployment.
Reducing debt and building emergency savings, as mentioned above, are two important steps you can take to prepare for the financial shock of a layoff. In addition, this is a good time to work to recession-proof your career: Update your resume, boost your network, and get the extra education, skills or training you may need to protect your livelihood.
Check out our Recession Survival Guide to learn more about living through a recession.
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Economic downturns are never pleasant and often painful. But with some thoughtful planning and the steps outlined above, you can protect your finances and better position yourself when the economy bounces back.
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This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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