Anna Rathbun, Chief Investment Officer
Protecting Your Investments During a Recession
Let’s start with the question we’ve probably all been wondering . . . are we currently in a recession? There's been a lot of debate over the past few months regarding the definition of a recession. Over the past several decades, a recession has been seen as two consecutive quarters of negative GDP growth print. Now, that's not a technical definition, but it is a good rule of thumb. The technical definition of recession is broad-based decrease in economic activity, and that’s decided by the National Bureau of Economic Research (NBER). However, the realityis that a recession is decided after the fact; it's all in hindsight. So, we probably won't know that we were in a recession and, if so, how long or how deep it was until we're out.
What Makes a Recession?
If we're not in a recession already, we certainly have risks of a recession, including:
• High Inflation — Particularly energy and food because these are necessities
• Falling Real Wages ― Adjusted for inflation, our wages have lost purchasing power. This makes us feel less financially secure, which tends to make us spend less. And we're a consumption-based economy; about 70% of our GDP calculation is based on consumption. When that declines, there lies the risk of recession.
• Tightening Financial Conditions — Rates are going up, and they are going up rapidly. This could lead to liquidity drying up. If you have to roll over debt for any reason, you'll be facing higher borrowing costs.
• Post-Pandemic Inventory Glut — Due to the backed-up supply chain, businesses were hoarding goods to ensure they had enough on their shelves. Now, with the economic slowdown, they may not be able to sell those goods. This is a classic, cyclical symptom of a recession.
Risk Creates Opportunities
Whether or not we’re in a recession, tough times lie ahead. However, for investors, risk creates opportunities.Economies move in cycles for a reason; it's an opportunity and a cleaning mechanism for that economy. Zombie companies often go bankrupt, and good companies tighten their belts, reassess the structure of their businessand go with leaner balance sheets so they’re prepared for future investments. They can emerge from a recession leaner and meaner. The bottom line is that we will get through this and re-emerge stronger.
It’s best practice for investors to diversify their portfolios, but it's been tough for diversified investors who have stocks and bonds because they’ve both gone down. If you’re a retiree depending on income from bonds, rates have been close to zero, but as rates have been going up, prices have fallen. It’s been difficult for all of us.
The Fed started to raise rates aggressively in March. However, I do think the toughest part of rate hikes affecting the bond market is behind us. Why? The hardest thing for bonds is when you're coming off zero percent interest rate. Yields not only provide income but also cushion to price volatility that comes from rate movement. So while rates were near zero, the bonds had little cushioning as rates rose rapidly. When you’re getting, for example, 0.9%in 10-year Treasury note, you’re exposed to nearly 100% of the price volatility.
What the Fed rate hikes have done, as painful as it’s been, is they’ve actually increased the yield on fixed income investments. Not only is that better income, it's also a nice cushion when it comes to price volatility. That's what I mean by the worst might be behind us. The volatility you've seen in bonds may be a little bit more dampened as we go forward because we have much healthier yield profiles to be able to dampen some of that price volatility.
So, when we’re thinking of potential opportunity in fixed income investments, the focus is on income. Because of the market volatility since the beginning of the year we’ve been emphasizing cash flow in our portfolios —whether it be trying to find different sources of income through bonds, in dividend stocks and for those who qualify, real assets. The rate hikes have made this focus on cash flow a little bit easier in the bond market.
Bond Asset Class Opportunities
In the bond market, the attractiveness of yield and diversification benefits from equity beta make it no surprise that U.S. government bonds and core fixed income are overweight. But due to the determination of the Fed to fight inflation and to raise rates, investors need to be cognizant of duration. We’re cautious on the international debt market as both developed and emerging markets do not offer the attractive upside compared to the downside risks. Here’s an overview of all asset class opportunities, weighted for today’s economy:
Bear Markets, Recessions & Bull Markets
Some might say we need to time the market and get out. The reality is that timing the market is impossible and therefore not a best practice. Take a look at the 2007-2009 line of the below chart; the bear market lost 57%, but the subsequent bull market was 401%. The point is, if you’re a long-term investor, what we’re experiencing mayjust be a blip compared to the bull market that may follow.
The current challenges in investing are all a part of the investment process. History has shown that most of the time the market goes up because it tracks a growing economy. So, when you're in the thick of it, and we've been in it for about ten months now, it feels like the pain will continue. However, if you look at it from a long-term perspective, what we’re experiencing is part of a cycle. Remember, it’s impossible to time when the market is at peak and when the market is at bottom.
Equity Asset Class Opportunities
On the equity side, we have U.S. Large Cap Equity and U.S. Small Cap Equity at weight because, believe it or not, despite all the issues we have in the U.S., this is still the place to be if you consider the global stage. We're only talking about the U.S. today in terms of recession, but there are a lot of international headwinds, including theenergy issues in Europe, thus the underweight indications.
The bottom line is that we have U.S. Equities at weight because on a relative value basis this is where we think we should be.
Building a Lasting Portfolio
What we've talked about in terms of at weight, overweight or underweight is based on today's market conditions.But if you’re a long-term investor or an institution with a liability, then you need a strategic asset allocation. To have a strategic asset allocation, it needs to be governed by an investment policy statement.
The question you need to ask yourself is, “What is my benchmark?” This is especially true for individuals. Your benchmark should not be the S&P 500. Rather, it should reflect your goals and what you want to be able to affordin life. It has to be a marriage of your life circumstances and available capital to be invested, and your portfolio has to meet that. So, just because you're young doesn't mean you have to be the most aggressive and vice versa.For institutions, your benchmark is your liability and your spending policy. It's not necessarily to beat any market. While that would be nice, your assets should be to be able to fund your liability and your asset allocation designed to meet those needs.In short, best practice is to set a long-term asset allocation — the strategic asset allocation — to meet whatever goals you have; that’s your benchmark!
• Diversified Portfolio — Even in this environment, even when things don't feel great, diversify your portfolio. This prevents us from taking unwise, concentrated bets on any single asset class.
• Dollar-Cost Averaging — If you're dollar-cost averaging, right now you're buying into a lower market, and that gives you an opportunity to buy into the market at a lower price than you did back in December of 2021.
• Rebalancing — Markets will do what they will do, but rebalancing discipline helps you to reorient your portfolio toward that long-term strategic asset allocation.
Again, the goal is to meet your benchmark, which is in the context of your organization and your life.Looking ForwardI've said that each recession is different, and each time people have risen to the challenge to get through them.We've been through many recessions. We've been through a banking crisis 14 years ago. We've been through two World Wars in the last century. We've been through a high-inflationary environment in the 70s, and we've been through Paul Volcker's overnight rate hike in the double digits in the early 80s. We've been through the different components of risks that I described earlier that we're seeing today in different forms. We’ve been through it, and we will get through it again.
So, I ask for your patience as an investor because the economy is meant to go in cycles. Nothing in nature ever moves in a straight line, and our economy certainly does not either. And, if you're a long-term investor, look beyond today’s volatility to capture tomorrow’s opportunities.The opinions expressed throughout the presentation are those of the author, Anna Rathbun. The information presented does not constitute advice, and you should not take any actions based on a perceived recommendation. If you have questions or would like to make individual financial decisions, consult with your financial advisor.
Investment advisory services provided through CBIZ Investment Advisory Services, LLC, a registered investment adviser and a wholly owned subsidiary of CBIZ, Inc.
The information included in this update is provided for informational purposes only and should not be construed as investment advice. The views expressed are those of the author based on the data available when this update was written and are subject to change based on market conditions or other factors. CBIZ Investment Advisory Services, LLC disclaims any liability for any direct or incidental loss incurred by applying information supplied in this update. Please contact your financial representative with any questions pertaining to the information in this update.