Economic Commentary: The Next Recession and Its Implications

Jan 29, 2019

Preparing_for_Next_RecessionDespite market volatility in recent months and the resulting dip in investor confidence, the typical investment portfolio is still far more valuable than it was 10 years ago, and the Dow has nearly tripled.1

In fact, we’re experiencing the second longest expansion period in the U.S. since World War II.2 If history is an indicator, the markets and economy aren’t likely to sustain an upward trajectory for long. Some economists point to rising interest rates, volatile markets, foreign trade tensions and an even more tense political climate as signs of another looming recession.3

When it will hit, no one can know with certainty. Investors and their financial advisors can, however, learn from the past and keep a pulse on economic and market indicators to inform future investment decisions.

Indicators and Implications of a Recession

When economic activity steadily declines for more than a few months, it can indicate a recession, according to some economists. Others cite a drop in GDP, income, production and sales over a set period as the “official” onset of a recession.4 What’s clear is that there’s no standard formula for the definition.

Among the many telltale signs of a recession is a rise in unemployment. Considering the present skilled labor shortage, which is expected to continue for the next decade,5 however, such an indicator may be less likely than in the past.

In a recession, businesses can expect fewer earnings and lower profits, and banks and financial institutions can expect credit losses as businesses and consumers tighten their budgets to make ends meet.

Government entities may increase their budget deficits even further than anticipated because tax revenues will likely decline as social spending increases to aid citizens who find themselves relying more heavily on government programs. In an effort to mitigate the impact on the economy and consumers, the Federal Reserve will typically lower interest rates during a recession. And, because the U.S. is a leading nation globally, the world economy can experience a slowdown as well.

What a Recession Means for Investors

As a recession approaches, the market will typically fall, but there are often several false alarms along the way. You can know a recession has hit its stride when you see the end of a bull market in common stocks due to a collapse in company earnings and cash flow. Meanwhile, government bond prices begin to rise as investors seek out investments that are free of default risk. You also can expect major industrial commodity prices, crude oil prices and commercial property values to decline due to disparities in supply and demand.

To put this in perspective, there was an average equity market decline of 28% over the past seven recession cycles. The mildest decline occurred in 1990 at a rate of 20% and the largest drop was 58% in 2009. During the 1971 recession, the average return on long-term government bonds was a low of plus 13%, while the 1991 recession had a high of 40%, with an overall average of plus 21% for all recession years combined. Long-term corporate bonds averaged 19% on total returns, ranging from 13% in 2000 to 42% in 1991.5

Investor Confidence Wanes

Currently, because of low unemployment and the ability to spend more, consumer confidence is relatively high, which often guards against a recession. Much of their confidence, however, lies in the hands of the Federal Reserve and the rate of inflation. The volatile market is also causing unease among many investors who are watching their portfolios ebb and flow.

While it does not appear to be likely in 2019, another recession is inevitable, and investor confidence will wane even further when it does occur. Communication with clients is key during times of uncertainty, and focusing on long-term investments with a healthy balance of diversification and risk control rather than trying to time the market to mitigate the risk of losses continues to be a strategic approach.

As the economy inches toward another recession, rely on the insights found in our quick-reference guide, Preparing for the Next Cycle. You’ll learn how you can help investors feel confident about their long-term financial goals by reducing risk and protecting gains. Get the guide now when you click the button below.

Preparing for the Next Cycle quick-reference tipsheet

SOURCES:

1Macro Trends, Dow Jones — 10 Year Daily Chart, 2019

2Forbes, Four Major Recession Indicators To Watch, And What They Signal Now, August 14, 2018

3USA Today, With the Economy Looking Shakier, Take These 5 Steps, December 16, 2018

4Investopedia, The Impact of Recessions on Business, August 7, 2018

5Public News Hour, Manufacturers Say Their Worker Shortage is Getting Worse. Here’s Why, November 16, 2018

MGA-2392729.1-0119-0221


Topics: Economic Commentary