Preparing for a Recession

May 30, 2022 | Marcia Zhou


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How to Mentally and Practically Prepare

It is difficult to precisely predict when and if a recession will happen. Although many indicators still show an expanding economy, the pullback in the stock market certainly reflects the uncertainty as to whether this growth is in jeopardy. Although recessions are part of a healthy investment cycle, the word ‘recession’ itself can spook investors and give flashbacks of the deep bear markets of the past. While in the midst of volatility, we believe investors need to first identify what type of bear market this could be. Given that markets have always found their way back to new all-time highs, by experience, all bear markets are temporal. However, some may be deeper and longer-lasting. In recent memory, those bear markets tend to come during periods of crisis like the Dot-com bubbles, housing crisis, financial crisis, and sovereign debt crisis. We do not feel the current pullback falls into such a category. Instead, we label the recent pullback a ‘Fed Tightening Cycle.’ In other words, the government is increasing interest rates and removing stimulus. We suggest that this event itself is not original, and investors have been through many tightening cycles. For that reason, this too shall pass. With that said, investors still need to prepare for market volatility as the markets attempt to reflect the appropriate odds that the Fed may not be able to cool the economy and inflation without first bringing about a recession. At these crossroads, we believe investors still have things they can do mentally and practically to get through these uncertain times.

Review your Portfolio and Diversify

Review the holdings in your portfolio and assess whether you own quality companies that will likely survive the given economic state. Ask yourself – will demand for the company’s products and services hold up during a recession due to specific brand, utility, or cost advantage? Are the companies over–leveraged, or is free cash flow intact? In past recessionary cycles, has management displayed an aptitude to cut costs and re-organize business practices to maintain margins, dividends and earnings growth?

As you review your portfolio, you should also assess if you have invested across various sectors, asset classes, and strategies. Although this may not prevent immediate losses, diversifying helps ensure that your investments will not be caught up in the one particular theme that may severely underperform. Keeping market exposure but capturing less downside is the key to surviving a bear market.

Don’t be a Hero but do Something

If the reasons why the market is trending in a certain direction are still present, the trend will likely continue. In the past, investors were encouraged to buy every dip because the reasons and catalysts for higher markets were persistent. Those reasons included: low-interest rates, government fiscal stimulus, and strong corporate earnings. Currently, in our view, the reason why this market has been volatile and down trending is that investors have been unable to get a grasp as to how far the government needs to raise rates. This uncertainty remains and therefore, we would be hesitant to buy every dip or participate in every mini-rally. Sometimes, with oversold markets, an investor may attempt to stand against the market and begin purchasing heavily. It can be okay for long-term investors to be early; however, they should also recognize that the market does not care that you have had enough of this selling! Of course, a client can and should make purchases at certain valuation levels. In our experience, the best time to be purchasing stocks is when you feel the most uncomfortable, not when you feel the most confident. With that said, we feel the best method is to dollar-cost average and to buy over time incrementally. In this current environment, we would not get more aggressive until we see the uncertainty around the Fed beginning to lift. Catalysts include evidence that inflation is peaking, the Fed providing more transparent economic targets that they are seeking to achieve, or the Fed signaling their plan to slow down the pace of their rate increases.

Take a Long Term View

Stock market crashes happen occasionally, but as mentioned above, recoveries and new all-time highs have always been achieved. Therefore one’s investment time horizon has always been an important consideration, and even though some of the nastiest drawdowns have been able to recover within just a couple of years, one cannot take the successful track record of the markets for granted.

If liquidity in the portfolio is needed within the next couple of years, the amount of risk one is taking in a portfolio should be lowered. Investors who do not have liquidity needs and hold a balanced portfolio have the luxury to stay patient and potentially treat pullbacks as an opportunity rather than a catalyst to sell.

There are many strategies to help protect one’s portfolio and hedge the risk of any further market pullbacks. Speak to your advisor for a more comprehensive understanding of how to manage your portfolio in these uncertain times.

 

 

 

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