For the last several months, economists have debated whether a U.S. recession is imminent and if so, when it will take hold of the economy. Meanwhile, investors anxiously anticipate what an economic downturn may mean for their portfolios.
If you're feeling a sense of unease or apprehension, you're not alone. Uncertainty can raise questions and fears, especially when your hard-earned savings and investments are at stake.
In this article, we’ll explore what a recession is, why experts are divided on its likelihood, and the potential implications for long-term investors.
What Is a Recession?
A recession refers to a significant decline in economic activity, generally identified by two consecutive quarters of negative GDP growth. By this definition, a U.S. recession doesn’t appear to be imminent.
In fact, GDP grew by 1.3% in the first quarter of 2023, according to the Bureau of Economic Analysis. Meanwhile, the Federal Reserve Bank of Atlanta’s most recent estimate for real GDP growth in the second quarter of 2023 is 1.9%based on its GDPNow model.
Despite these data points, the National Bureau of Economic Research (NBER) is responsible for officially declaring recessions. While its definition of a recession is somewhat murky, NBER considers factors such as real personal income and unemployment rates to determine if the U.S. is in a recession.
Why Can’t Economists Agree on Whether a Recession Is Imminent?
Competing economic data has economists divided on whether the U.S. is heading into a recession.
On the one hand, the Federal Reserve’s projection of low GDP growth for 2023 combined with its efforts to fight inflation by aggressively raising interest rates have fueled concerns about an economic slowdown for some time.
A minor banking crisis earlier this year added to concerns of a tightening credit market. High interest rates coupled with stricter lending standards could weaken business and consumer spending, potentially accelerating an economic downturn.
Meanwhile, the yield on 2-year Treasuries has topped that of 10-year Treasuries since 2022, causing the yield curve to invert. This is significant since an inverted yield curve has historically been a reasonably reliable predictor of recessions.
Consequently, the New York Fed’s recession probability indicator suggests a 68% chance of a recession in the next 12 months as of May 2023.
Positive Economic Signals
Indeed, there are reasons to fear an impending U.S. recession. However, the resilience of the U.S. economy has surprised many experts, suggesting that a recession may be farther off than expected.
For example, although the labor market shows signs of cooling, it remains at healthy levels. In April, U.S. employers added 253,000 jobs and the unemployment rate fell to 3.4%, its lowest level in 54 years.
At the same time, consumer spending rose 0.8% in April, according to the Commerce Department. This compares to increases of 0.1% in both February and March.
What Would a Recession Mean for Financial Markets?
Historically, most U.S. recessions have coincided with a sharp decline in stock market performance, at least initially. However, this isn’t always the case. While every recession looks different, history suggests that long-term investors would be wise to stay the course.
First, U.S. recessions have historically been relatively short-lived, lasting approximately 10 months on average. And in five of the last 11 U.S. recessions, the stock market was back above its breakeven point by the time the recession was over.
Although economic and market declines can be difficult to stomach, they also tend to create attractive buying opportunities for investors. On average, the S&P 500 has generated a return of 40% in the 12 months following the market’s low point in a recession.
On the other hand, bonds—particularly U.S. Treasury bonds—often fare well during recessions as investors flock to safety. This increase in demand tends to push bond prices higher and send yields lower.
In fact, the bond market already appears poised for a rebound as the Fed considers pausing its rate hike cycle. Some experts are even predicting that the total return potential for bonds this year may surpass that of stocks, which would be a welcome turnaround from last year when the U.S. bond market experienced its worst year ever.
Practical Tips for Investors
While recessions can introduce volatility and uncertainty, they also tend to present opportunities for patient investors. Here are some practical tips for successfully navigating a potential recession:
- Stay the course. Knee-jerk reactions can often do more harm than good. Stick to your long-term investment strategy and resist the temptation to make impulsive decisions based on short-term market movements.
- Diversify your portfolio. A diversified portfolio can help mitigate the risk of significant losses. Consider spreading your investments across various asset classes such as stocks, bonds, and cash equivalents.
- Rebalance as necessary. Market changes may cause your asset allocation to drift from its target. Regular rebalancing helps ensure your portfolio stays aligned with your investment goals and risk tolerance.
- Consider the role of bonds. High quality bonds often fare well during recessions as investors look for safer havens. While it may not be wise to shift all your investments to bonds, it’s important to understand their role in a balanced portfolio.
- Consult a trusted financial advisor. A trusted financial advisor can provide invaluable guidance during uncertain times and help you avoid knee-jerk reactions that undo years of progress toward your long-term financial goals.
Remember, recessions are a normal part of the economic cycle. With expert guidance and a sound financial plan, a recession doesn’t have to keep you from achieving your long-term financial goals.
A Trusted Financial Advisor Can Help You Weather the Storm
While the prospect of a U.S. recession can seem daunting, it’s important to remember that challenges often create opportunities. Historically, markets have not only endured economic downturns, but they’ve also demonstrated impressive resilience and capacity for recovery.
As experts continue to debate whether a recession is imminent and market volatility remains heightened, it’s important not to panic. By staying focused on your long-term goals, you can weather the storm and position yourself for financial success.
Remember, we’re here to help. If you're concerned about how a potential recession could impact your financial future, please don't hesitate to schedule a call with us today.