Recessions occur when economic output declines after a period of growth. They are a natural and necessary part of every business cycle. Attempting to predict the exact timing of recessions is impossible. The fact is the U.S. economy has only been in recession about 15% of the time in the post-war era, and as the old saying goes: “economists have successfully predicted 9 of the last 5 recessions.”
The good news is that recessions generally don’t last very long. Over 10 cycles since 1950, U.S. recessions have ranged from 8 to 18 months with the average lasting 11 months. So what happens to the markets? Just as equities typically lead the economy on the way up, they also lead on the way down. The S&P500 typically bottoms out about 6 months after the start of recession and usually begins to rally before the economy starts improving again.
So what can we do to prepare for a recession?
Aggressive moves such as shifting your entire equity portfolio into cash can often backfire. Two other approaches tend to have worked better over time:
1. Ensure an appropriate asset mix and rebalance
No matter your age and stage of life, you are unlikely to have all of your investment assets in the stock markets. In preparing for a recession, we review your overall (all assets) asset mix with you to make sure you are comfortable with the asset mix you hold. Perhaps now is the time to move to a more conservative position.
We take care to make sure your assets are being rebalanced regularly both now and during the recession. If your “target asset mix” is 50% stocks / 50% bonds and the recession pushes the bonds up and stocks down, rebalance back to the 50/50 mix thereby “selling high to buy low”. This strategy will serve you well over the years to come.
2. Create a “cash cushion” covering 2 years’ worth of expenses
Studies have demonstrated that drawing upon a declining portfolio can be very detrimental to your portfolio over time. We work with you to make sure you have cash or regular dividends set aside for any expenses (regular or emergency) that you may need over the next little while. This will ensure you do not need to access your investments during the down period in the markets. This type of “insurance” proved to be very beneficial to our clients during the 2008/09 “Great Recession”.
Bottom line – we cannot entirely avoid the consequences of a recession. However, we can ensure that we are prepared to “weather the storm.”