The Next Recession – To Swerve or Not to Swerve – Visionary Wealth Advisors

The Next Recession – To Swerve or Not to Swerve

John Fischer, CFA®, CFP® | Chief Investment Officer
June 5, 2019

The current economic expansion has lasted almost 10 years now, soon to be the longest on record. Some investors see that looming 10-year anniversary, coupled with the recent market volatility, as a reason to worry about when the next recession will occur.

We know that nothing lasts forever – especially not bull markets. The market moves in cycles and we should expect a recession to follow this expansion. The only thing we don’t know is when.

What should investors do to prepare for this inevitability? Consider this scenario to find the answer: You’re driving down the road when a deer darts in front of your car. Do you swerve to avoid the deer or hold the wheel steady?

If you swerve out of your lane (and into a ditch, tree, or oncoming traffic) to avoid the deer, you expose yourself to greater risk of injury than staying in your lane and possibly striking the deer. Given that the deer is likely running, there’s also a reasonable chance by staying in your lane it will clear your lane and you can both pass unharmed.

You should hold the wheel steady and avoid swerving. But even if you know that’s the objectively best thing to do, your impulse and emotion may override that knowledge in the moment. Most drivers reflexively jerk the wheel anyway.

The Unpredictable Deer in Your Lane as an Investor: The Next Recession

 Investors display similar impulses when experiencing market fluctuations or nerves about the next recession. Instinctually, investors want to swerve, altering portfolios to be more conservative or increasing cash allocations in hopes of missing the downturn.

This presents the same problem as the swerving driver does: investors trying to avoid the next market downturn expose their portfolios and long-term financial goals to more risk than they would if they stayed appropriately invested.

And don’t forget the other reason for not swerving around a fast-moving animal: there’s a chance there simply won’t be a collision.

How many times have experts predicted a recession that never came? There have been 10 recessions in the U.S. since 1950. Despite an abundance of economic data to leverage, economists and market experts have never successfully predicted future recessions with a high degree of accuracy.

Don’t swerve to avoid something you may never hit anyway – and don’t tinker with your portfolio based on predictions of an event that may not happen when you think it will.

The Cost of Getting Things Wrong (and Why You’re Unlikely to Get It Right)

If you try to sidestep the next market downturn, you face the daunting task of choosing precisely when to swerve out of your current strategy but also when to swerve back.

Timing the market correctly once is difficult enough. Doing so correctly twice is even more unlikely because investors who try often sell when they feel bad and buy when feel good. This strategy of investing leads investors to buy high and sell low, which creates disappointing results in a financial plan.

Since 1900, the average length of market expansions has been 48 months. The average length of recessions has only been 15 months.1 We spend about triple the time in market expansions on average as recessionary periods.

If an investor decides to swerve to miss a potential recession, they’re much more likely to miss part of an expansion than a recession. The average recession is almost over by the time investors realize there is a recession, meaning investors who swerve risk getting out of the market after they’ve already endured the greatest pain of the downturn.

You only need to look back at the last few years to find ample evidence of moments when investors were convinced they should swerve:

  • In the fall of 2016, investors felt uncertain about the outcome of the Brexit vote, stretched market valuations, and the U.S. presidential election.
  • In early 2018, the market experienced its first correction in 2 years due to concerns about rising inflation and the initiation of tariffs against our largest trading partners.
  • In late 2018, stocks plummeted nearly 20% due to ongoing trade dispute fears and a Fed that continued to raise rates.

Investors who swerved by going to cash during these times missed out on the continued expansion and market rally that followed each of these events. Those who stayed the course didn’t pay the substantial costs of getting it wrong.

Think Before You Swerve

 With rising concerns over the trade dispute with the U.S. and China, ongoing geopolitical risks, and uncertainty with Brexit and European elections, there is no shortage of risks that can trigger fear of loss.

But rather than trying to predict the next market downturn and when to swerve to avoid it, long-term investors should consider simply preparing for it. Preparation starts with owning a diversified portfolio, thereby reducing the chance all of your investments move in the same direction at the same time. Diversification can help reduce, but not eliminate, losses in a market downturn.

You can also prepare by ensuring the mix of stocks and bonds that you own aligns with your personal risk tolerance and time horizon. Your allocation may be in need of some attention after a 10-year bull market; make sure you’re not taking on more risk than you can truly handle.

As investors, there will always be market risks that make us want to swerve our portfolio away from our long-term plan. But by knowing the low chances of getting it right by swerving and the high cost of getting it wrong, investors can arm themselves with knowledge that can help them stay on the investing road even when their instincts are telling them to swerve.

Source:    1 www.nber.org/cycles/


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