It may be a little early to talk about recessions but there is no harm in preparing for one if it arrives in the next few months. No one can accurately predict when a recession will start. A lot of economists have ruined their reputations by making incorrect predictions. Even you and I can only make a guess but what we can ascertain easily is what causes a recession and what happens when a recession starts.
“A recession is a significant decline in economic activity lasting more than a few months, visible in real GDP growth or decline, income and employment trends.”
The 2020-2022 market environment has some similarities to the dot-com bubble of the late 1990s and early 2000s. In each boom we see tech stocks going very high, hundreds of IPOs, the rise of day-trading and many people quitting their jobs to jump into trading, new types of speculation like crypto, NFTs, etc. and people being in hurry to get rich. And in each bubble burst we can see tech stocks getting crushed, high-flying securities falling 60-90%, retail trading coming to a halt, value stocks becoming popular once again and investors learning a lesson again from the market.
Over the past month, there has been a many downward revisions to growth forecasts for the U.S. and the world.
Talk of a U.S. recession started when the yield on two-year treasuries dipped below that for ten-year treasuries (a so-called yield curve inversion) for some time in late March. The yield curve has historically been a far more accurate predictor of a recession than any economist.
The U.S. GDP for the first quarter was weak, showing that the economy contracted by 1.4% in the first quarter of 2022 (on an annualized basis).
Volatility in the stock and bond markets will remain high over the next few months, and both U.S. and global growth will slow down or start shrinking in some countries.
“Fearing stagflation and higher interest rates, global money managers have been amassing cash at a level not seen in two decades.” says Bank of America. Investors are putting money in the safer sectors of the economy and taking out from the riskier sectors as can be seen from the chart below.
How should we prepare?
Don't change your plans — Even if a recession is inevitable, we don’t know how severe it will be and how long or short it will be.
Maintain your cashflows — It’s hard to find a job during a recession, so make sure you have a secure job, steady business or any other source of income.
Keep cash aside — It's always a good idea to have liquid assets — cash, money market funds, etc. to cover daily needs or unexpected emergencies.
Don’t let your emotions guide you — Don't let your emotions get the better of you when you see the daily ups and downs of the stock indices. The best way to meet your long-term goals is to just stay invested and stick to your asset-allocation.
Don't trade on the headlines — Making financial decisions based on an impulsive response to current events usually leads to financial disaster.
Check your portfolio — Review your holdings to make sure they are within your risk tolerance level. If you don’t feel comfortable with any security, get out of it.
Make new investments slowly — If you have a large lump sum, invest in smaller portions periodically for a period of time - rather than all at once.
Billionaire hedge fund manager Paul Tudor Jones recently said “I think we’re in one of those very difficult periods where simple capital preservation is I think the most important thing we can strive for.”
We have to remember that economic contractions are a feature and not a bug of the economic system — it’s a part of the overall economic cycle and we have to learn to deal with it.
It's impossible to make perfect choices since no one has perfect information. The facts keep changing all the time. Try to make the best decisions based on those facts keeping in mind your individual goals and risk tolerance. If you have enough in liquid emergency savings and some extra cash, you are providing yourself with more cushion and more options.
Disclaimer: I write for educational purposes only. The information in this publication is not intended to constitute investment advice. Consult your financial adviser before making any investment decisions. I may or may not have positions in the securities covered in my articles. This is not a recommendation to buy or sell securities.