Last week, I sat down with one of my long time clients. She and I were discussing the volatile stock market as of late, and I was sharing with her that corrections and pullbacks are a part of a normal, healthy market. (I’ll define a correction as the stock market dropping by more than 10% and a pull back where the market drops by more than 5%.) She was surprised to learn that since the end of the last recession we have averaged about 2 pull backs or corrections a year.
“It hasn’t seemed that volatile until this year,” she said. I agreed and shared that up until January of this year, we hadn’t seen either a pullback or correction since February of 2016! That’s an unusually long period of calm on the up and the down side. That then led to her next question, “So if the recent volatility doesn’t concern you, just what would it take to make you worry about another recession?”
2008 isn’t far from anyone’s mind, and proves that recessions are still one of the biggest fears investors have. While every recession is different, we can look back and see each recession we’ve had in modern times was preceded by an inverted yield curve. That’s were short term interest rates are higher than long term interest rates. Just to clarify, we’ve had inverted yield curves in the past where we did not get a recession so an inverted yield curve doesn’t automatically mean a recession is coming, but it would definitely get my attention.
Lenders usually look to the Fed when it comes to setting interest rates. So when short term rates increase, banks will typically raise their prime rate, making it more expensive for businesses and consumers to borrow money. This, in turn, leads to a slowdown of activity which then can lead to a recession.
Recessions are generally blamed on a shock to either demand or supply. These shocks can come from any number of areas. Sharp increases in commodity prices (inflation), interest rate hikes, businesses making poor investment decisions which when discovered leads them to rapidly unwind those decisions. Think along the lines of the mortgage crisis, housing bubble, and the earlier dot com bust.
But, the thing to always keep in mind is that recessions are part of the business cycle. They are the method the market uses to unwind bubbles.
I encouraged my client, as I encourage all of you to worry less about the things that are outside your control and assure you’re on top of the things that are inside your control. At this point we don’t see much chance of a recession in the near term, but don’t let that serve as an excuse for putting off planning.
It’s in times of chaos that we often see a strong financial plan offer priceless peace of mind. Whether it’s assuring you have a large enough emergency reserve, appropriate management of your income sources, or making sure you are well diversified in your investments, proper planning can allow you to weather a recession much more comfortably (although, I make no claims that a recession will ever be comfortable).