Is a Recession Right Around the Corner?

We speak with Dave Alison, CFP, EA, BPC, president of C2P Enterprises, on whether investors should be expecting a recession soon, as well as how investors can navigate today’s economic threats while also preparing for a potential recession. Dave also shares some reasons for investors to be optimistic. 
 
With Q2 seeing another quarter of negative growth, is recession right around the corner?
 
Recessions are incredibly hard to predict before the fact. Recessions are always identified with a lag and by the time one is called, the worst of its impact on markets has usually passed.
 
The issue is that the National Bureau of Economic Research (NBER) identifies phases of the business cycle using a bevy of indicators, such as consumption and income data, employment rates, and gross domestic product growth. None of these measures has been consistently dominant in the determination of economic conditions, and certainly past U.S. recessions have come in all shapes and sizes.
 
Could a recession be right around the corner with another quarter of negative growth? Possibly, but two positive signs that it is not are the strong labor market and the continued pent-up demand by consumers. Has the economy weakened? Yes. Is it time to throw in the towel and declare a recession? I don’t think so.
 
Do signs point to another quarter of negative growth? What can we expect in Q3? 
 
A lot is going to be determined by whether consumer spending can keep up with inflation.
 
Companies are having a challenging time forecasting earnings and revenue, which is causing some companies to become defensive. This means hiring freezes, cutbacks in spending, and expecting more productivity squeezed out of the resources they have. Some industries and sectors are having a harder time than others.
 
I believe we can expect continued volatility in Q3 while the inflation data settles in, and we see the impact of the Fed’s interest rate hikes.

 
How can investors navigate today’s economic threats while also preparing for a potential recession? 
 
The best advice I could give is to have a plan for how you are going to deal with volatility and work towards de-risking concentration risk in your portfolio.
 
When investments become volatile, investors make behavioral mistakes and react with emotions and not logic. They tend to sell out of the investments after they have fallen, and they do not get back in until after they have recovered. This is what we call getting whip-sawed and it makes it incredibly hard to recover financially.
 
We believe everyone should time-segment their money into three buckets, i.e., have a Bucket Plan:
 
Your Now bucket should provide you liquidity for the next 12 months and remain in cash. This should be income needs for up to 12 months, any major planned expenses, as well as a sufficient emergency fund.
 
Your Soon bucket should be invested for growth to offset inflation, just invested more conservatively or defensively so that this bucket of money doesn’t experience major downward swings in the market. Since this money is invested conservatively, it would be your “income” money for the next 5-10 years if you are in retirement or your “opportunity” money if you are still in the accumulation phase of the money cycle.
 
Between the Now bucket and the Soon bucket you have plenty of money to get you through any downward economic cycle without having to sell investments at a loss for the income or withdrawals that you need.
 
The Later bucket is where you have a long-term investment time horizon and can properly allocate your investments to achieve maximum growth. Because you have bought a time horizon between your Now and Soon buckets of money, you have the confidence to stay the course and capture stock market returns.
 
What are some top mistakes investors make during market volatility and economic uncertainty and how can they avoid them? 
 
The biggest mistake is acting with emotions and selling good investmentsbecause you cannot tolerate seeing your account balances go down. At the end of the day, we all hate seeing our account values go down, but that is part of being an investor. The market doesn’t go up forever, and volatility in investments is what drives higher expected returns. To participate in all the good the market can afford us, we must be willing to roll through the bad times and not panic.
 
Another common mistake investors make is failing to take the time to strategically rebalance their portfolio. During these volatile times, there is a good chance that your portfolio style has drifted as some asset classes have performed better than others. Strategically rebalancing your portfolio helps get back to your ideal target asset allocation by selling of some of the winners and allocating that capital to sections of your portfolio that haven’t performed as well.
 
This may seem counterintuitive because you might wonder why you would want to sell off the good performers to buy something that has not performed as well, but the reality is for many asset classes that this year’s winner is next year’s loser and vice versa. Strategically rebalancing helps avoid building concentration in any given asset class and helps you systematically continue to buy low and sell high.
 
Another top mistake is overlooking tax management opportunities. When markets become volatile and prices go down, you might have strategic tax management opportunities such as converting your IRA to a Roth IRA while prices are lower. When prices rebound, and that rebound happens in your Roth IRA you have eliminated the IRS from taxing any of that gain! There is also opportunity for tax-loss harvesting in a portfolio to create deductions or offset other gains.
 
The last is investors stay anchored into positions for too long. Maybe you bought some great stocks in the downturn of 2020 when Covid brought havoc to markets, and you experienced incredible gains over the last 2 years. In many cases these positions could now account for a higher concentration of your overall portfolio than you would like, but many consumers didn’t strategically take gains off the table by de-risking and reducing concentration.
 
Even worse, many stocks that people piled money into over the last year have now fallen in value, but investors are staying anchored into those stocks in the hopes they will return to their pre- 2022 sky-high valuations instead of taking the gains and redistributing those funds to other investments that could perform better in this new environment we face.
 
What are some reasons for investors to be optimistic in a recession?
 
The biggest reason to be optimistic is that downturns are temporary but the wealth you can accumulate during those downturns can be life changing. For investors who are prepared, these downturns can create buying opportunities of a lifetime.
 
If you are not confident that your goals, objectives, and financial plan can weather the storm of a recession or market correction, then I would argue you probably don’t have a well-coordinated plan and there is good reason to be worried.
 
For those investors who have a plan that is built to not only survive but thrive through economic downward cycles, there is plenty to be optimistic about as they get to focus on all the other areas of life that bring them enjoyment.

This interview originally appeared in our TradeTalks newsletter. Sign up here to access exclusive market analysis by a new industry expert each week. We also spotlight must-see TradeTalks videos from the past week.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Other Topics

Economy Investing