If you turn on the news or browse headlines online, you’re likely to see stories about inflation, rate hikes, market volatility, and — the mother of all bad news — recession.
With all this uncertainty floating around, it’s hard to distinguish the noise from reality.
Having a knowledgeable perspective on what a recession is and how you can financially prepare may help ease concerns and ensure your financial plan stays on track.
So, here’s what you should know about what causes a recession, how to prepare, and what to do if a recession occurs.
What is a recession, exactly?
It may be surprising, but there isn’t a hard and fast rule to describe a recession.
One widely accepted definition, however, is when there are two consecutive quarters of falling gross domestic product (GDP).
The National Bureau of Economic Research also defines a recession more subjectively as “a significant decline in economic activity that is spread across the economy and that lasts for more than a few months.”1
While recessions vary in length and severity, the good news is history shows they end fairly quickly. Since the Great Depression, the average length of a recession has been just over 11 months.2
Although recessions might not be welcome news, they are a normal part of the economic cycle. In fact, except for the 2010s, we’ve seen at least one in every decade since World War II.3
What are the chances of a recession in the next few months?
It’s impossible to predict whether a recession will happen, but there are certain economic factors you can reference for potential indicators.
Employment is one of those indicators. When GDP falls, the economy needs less labor. As a result, businesses typically reduce their workforce and the unemployment rate increases. So far, our unemployment rate has remained at healthy levels,4 which may signal that the economy is still strong.
Another typical sign of a recession is a decline in consumer spending. Think about this as a precursor to falling GDP. If consumers start spending less, then demand will fall causing businesses to cut back. However, personal expenditures have actually increased every month of 2022.5
Still, the reality is that interest rate hikes implemented by the Federal Reserve to fight inflation place some pressure on the economy. But these other strong conditions, and historically low rates, mean the Fed has room to raise interest rates before a recession may be triggered.6
Experts’ opinions on whether a recession is imminent remain somewhat mixed. Most have increased their expectation of a recession, but many still think it is unlikely. For example, Goldman Sachs has recently placed the odds of a recession at 35%, while Morgan Stanley’s estimates are closer to 30%.7 However, even experts that think a recession is likely, expect it to be short-lived.8
What should investors do to prepare for a potential recession?
With the possibility of a recession looming, here are a few precautions you can take to provide yourself financial protection and soften the blow of a down market.
Build your cash reserves
While having enough cash on hand for essentials and an emergency fund is a crucial financial tip in any market, it’s especially important during times of heightened volatility. To ensure you have enough cash reserves, tally up your housing, food, medical, and other necessary costs. In a household with two income-earners, savings for three months of total living expenses are typically adequate, while one-income households may wish to save enough for six months.
If you come up short, it may be time to focus on building your cash reserves.
Avoid trying to time the market
When it comes to your investments, sometimes inaction can be more valuable than action. Unfortunately, panicking or trying to time the market could do more harm than good. In fact, studies show that this attempted strategy could significantly decrease your returns over time.9 Remember, if you have a long-term plan in place, it should already account for the occasional market dips.
Rebalance if necessary
A recession may hit certain asset classes harder than others. Therefore, it may be necessary to rebalance to keep your portfolio in line with your overall financial plan.
For example, if you intend to hold 70% of your portfolio in stock allocations, and turbulence causes them to fall below this threshold, then it may be time to rebalance back to your target allocation.
Don’t stop your investment contributions
If you can, continue making your regular contributions and investing. Individual shares might be cheaper during a recession when the market is down, meaning your contributions will buy a greater number.
If you stay the course and continue investing, you’ll have purchased more shares at a discounted rate. Over time, this can help reduce volatility and lower your average cost per share.
Feel confident in the face of a potential recession
Although recessions can raise some concerns, it helps to remember they are a common economic event. Sticking to your long-term financial plan can help you ensure you don’t stray too far away from your goals.
Are you confident that your current plan is right for you, or is the risk of recession weighing on your mind? We’d love to help you gain clarity, identify potential gaps, and take the necessary steps to ensure you are prepared. Reach out to our team to learn more about how our financial advisors can help you stay calm in the midst of challenging economic times.
The commentary on this website reflects the personal opinions, viewpoints, and analyses of the Trinity Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Trinity Wealth Management, LLC or performance returns of any Trinity Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Trinity Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Sources:
1 “Business Cycle Dating Procedure: Frequently Asked Questions,” National Bureau of Economic Research
2 “Recession: When Bad Times Prevail,” International Monetary Fund
3 “Recession: 10 Facts You Must Know,” Kiplinger
4 “The Employment Situation – June 2022,” U.S. Bureau of Labor Statistics
5 “Personal Income and Outlays, June 2022,” U.S. Bureau of Economic Analysis
6 “Will the Fed Cause a Recession By Raising Rates? Here’s What Experts Are Saying,” Bankrate
7 “The Likelihood of a U.S. Recession Jumps to 38% in a New Bloomberg Report,” Fortune
8 “‘Uncomfortably High’: What Economists Say About the Chance of Recession,” The New York Times
9 “Is market timing worth it during periods of intense volatility?” JP Morgan Chase
