Are we going into a recession? This question has been in the news and on the minds of investors for months, and the recent announcement that GDP has decreased for the second straight quarter makes the question even more pressing.
A recession implies trouble for investors. Many believe that once a recession is announced, the stock market will drop sharply – and so changes will be needed to their portfolios to weather the storm. But history indicates a different scenario. Instead of dropping further when a recession is officially announced, the market often moves up.
That is because, in part, recessions are often declared several months after they have started. The National Bureau of Economic Research, a private, non-partisan organization, makes this call after analyzing many economic data points that take time to collect. This information includes, but is not limited to GDP growth.
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Why Now May Not Be the Time to Be Defensive
But research by CI Brightworth in Atlanta shows that once an official recession is announced, much, if not all of the market’s downturn has already taken place. So, getting more defensive after a recession is announced may be the worst thing an investor can do.
In three of the last six recessions since 1980, the stock market hit a bottom before the recession was officially recognized. Even more important for investors, after those six recessions, the market quickly moved up five times – ranging from 10.3% to 34.5% only one year following the recession announcement. Strong gains continued for three and five years after a recession was declared – in three cases, the gains topped 100%.
So, what does this mean for investors? The data show that taking defensive actions when a recession is announced has worked poorly in five of the six last recessions. A defensive action ranges from reducing exposure to stocks all the way to the “big mistake” of shifting the entire portfolio to cash.
So, what is an investor to do? Here are three recommendations:
Stop Trying to Time the Market
Trying to get into and out of the stock market is a fool’s errand and one of the biggest wealth destroying actions an investor can take. The market is forward looking and moves prior to the underlying economy. If you’re trying to move into and out of the market based on what’s happening in the economy, you are more likely to do the wrong thing at the wrong time and harm – not improve – your returns.
Stay Disciplined
If you are investing new money, either through your 401(k) plan, individual retirement accounts (IRA) or other plans, continue to follow your long-term investment strategy. You should be excited about the opportunity to buy more stocks when they are “on sale.” If it feels painful to add money to a falling market, consider automating your contributions and investments so you can reap the benefits of lower valuations without contemplating the market’s every move.
Add Stocks to Your Portfolio When They are Down
Use the downturn to rebalance your portfolio by selling assets that have performed the best and buying the assets hardest hit by the market’s tumble. For example, this could mean selling investments in some commodities and real estate while picking up high-quality stocks that have lost a significant amount of money this year. Rebalancing your portfolio is one of the most effective ways to ensure you follow the classic adage of buying low and selling high.
No one knows when the next recession will arrive or how the market will respond when it does. However, by following these key steps, investors can be prepared for any further volatility while also helping to favorably position themselves on the other side.
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