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Get ready for the next recession in 9 steps
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Loading...When will the next recession occur?
This is one of the questions we hear most often. And that's why you have a good reason. Recessions can be complex, misunderstood, and sometimes even frightening. The economic expansion of the United States is entering its tenth year. That's what investors are thinking about whether it is not over, and the next recession is "just around the corner."
Many analysts, however, still have the firm opinion that this year there will be no recession. Most of them believe that the conditions for it will be born in 2020 even in 2021. But economic cycles are known to be difficult to predict.
What are recessions?
They typically have the following definition: At least two consecutive quarters of declining GDP after a long growth period. Or the longer definition: Significant reduction in economic activity across sectors, to last more than a few months. With impacts on GDP, real incomes, unemployment, industrial production and wholesale.
What causes recessions?
Past recessions have happened for a number of reasons. The most common case, however, is when the balance of the economy is disturbed and consequently correcting this imbalance. For example, the 2008 crisis was caused by the huge surplus of debt collected in the mortgage market, and in 2001 the contraction in the economy was triggered by the burst of the technology bubble.
Although each economic cycle is unique to itself, some common causes of recession are: rising interest rates, inflation and resource prices. Everything that hurts corporate profits enough to cause a strong contraction is also a strong reason.
When unemployment rises, consumers reduce their savings, which further reduces economic growth, company profits and share value.
How long does the recession last?
The good news is that recessions are not very long. Looking back, we will see that 10 economic cycles since 1950 have been followed by recessions within 8 to 18 months and an average recession lasts 11 months. For those who are direct victims, losing their jobs, or their business closed, it can be felt as an eternity. But investors with long-term horizons should remain calm because the future will bring them profits.
Recessions usually appear to be small spots in economic history. Over the past 65 years, the US has fallen into recession in 15% of the time. The net effects on the economy as a whole were quite small. The average economic upturn led to an expansion of 24% and average recessions reduced US GDP by less than 2%. Rates in shares may be positive over the entire contraction period, as some of the strongest stocks have managed to withstand the final stages of the recession.
What happens to the stock market during a recession?
Even if it does not immediately follow a recession, it is never too early to think how it would affect our portfolio. This is because usually bear markets and recessions overlap at times - stocks lead the business cycle with up to seven months on their up and down path.
During a recession, the stock market usually continues its sharp decline for several months. Frequently, the market has formed a bottom six months after the start of the recession. Usually a new rally starts before the economy starts recovering.
Aggressive large-scale moves, like the conversion of the entire portfolio into caches, may sometimes be fatal. Some of the best profits come in the late phase of the economic cycle or just after the bottom is formed. The better option is to stay on the market in order not to lose the benefits of upward movements.
Which economic indicators warn of a recession?
Will not it be great to know exactly when the recession will come? Despite the inability to accurately determine the start of such an event, there are some relatively reliable signals that are worth tracking in the late cycle of the economy.
Four indicators that can warn of a recession early are the yield curve for bonds, corporate earnings, unemployment and new housing construction.
Reversing the yield curve may sound like a gymnastic exercise, but it is actually one of the most accurate signals. The curve turns when short-term bonds become more expensive than long-term bonds.
This signal has been a precursor of American crises for the last 50 years. Short-term bonds usually rise when the Fed begins to tighten the economy. Long-term bonds fall when they have a strong demand. In December 2018, we had a reversal of the curve for the first time since 2007. Even if this happens, however, it is not always a sign of immediate panic. Usually after this event, recessions occur after 16 months.
How close are we to the next recession?
Economic indicators are the way in which the state of the economy can be measured. One or two negative readings will not matter. But when several sectors start to shine in red for an extended period of time, the picture becomes clearer and measurement becomes much more important. According to the chart below, this time has not yet occurred.
Although some imbalance is currently emerging, it does not seem to be extreme enough to hurt economic growth in the short term. The main suspect, however, that could sink growth is the interest rate coupled with high levels of debt and rising inflation.
If these events continue, this suggests that the economy may weaken in the next two years, which is a prerequisite for a recession in 2020.
How do we position our portfolio in equities during a recession?
It has now become clear that stocks are performing poorly during a recession, but trying to sell stocks may also be a bad idea. This does not mean investors do nothing.
In order to prepare for a recession, investors have to take the opportunity to review their portfolio, which has certainly undergone major changes during the bullish market. You have to be sure that it is balanced and widely diversified.
Not all shares react in the same way during economic stress. During the last eight recessions, some sectors have performed better than others. Mostly those with a higher dividend. Dividends can offer a good passive income against the background of stock devaluation. Even during a recession, many companies remain profitable.
How do we position our portfolio in bonds during a recession?
Fixed income is the key to our successful survival during a recession. Bonds offer a vital measure of stability and capital conservation, especially when the stock market shakes.
In the last six market adjustments, US bonds were flat or positive in five out of six recession periods.
Achieving a balanced defensive portfolio is always important. But when the US economy is a late economic cycle, it is critical that investors begin to focus on bonds.
What do you need to do to prepare for a recession?
First of all, investors need to stay calm and look long-term when investing before and during a recession. Emotions can be one of the main obstacles to achieving strong investment goals, especially in times of severe economic turmoil.
Below you can see an example portfolio with good balance between US and foreign stocks, fixed income instruments and various risk profiles.
* This is not investment advice. This is a portfolio model entirely built on sample assets and an investment hypothesis.
The next recession will ever happen. This is an indisputable fact. It can come in a year or two. Whenever it is good to prepare mentally and financially. We need to change the design of our portfolio to ensure survival, and yet some profitability, a portfolio that endures in times of economic uncertainty and extreme volatility.
Trader Martin Nikolov Read more:
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