Not all recessions play out the exact same way. And right now we have the added complexity of dealing with the Coronavirus. If this is the first time you’ve experienced this economic cycle, here’s what you can expect to happen in the coming months.
What is an Economic Cycle?
Economies go through four phases as part of the economic cycle — the expansion, peak, contraction and then the trough. The length of time it takes to experience these cycles vary, but historically we’ve seen this phenomenon play out the same way over and over again.
Expansion is the phase that marks a growing economy — GDP is healthy, unemployment is low (in the 3% to 4.5% range), inflation is normal — around 2% — and the stock market posts regular gains. Eventually the markets and all other economic indicators hit a peak. And it’s all downhill from there.
When exuberance over the economy’s good health overheats — when everyone expects the good times to go on forever — reality sets in and we experience a contraction. This phase which we’re in right now happens quickly, driving down GDP, stock market returns (as investors start selling) and causing the unemployment rate to eventually rise as companies are forced to lay off employees.
When GDP growth has turned negative two quarters in a row, that’s when economists say we’re in a recession. Next, we enter the final stage of the cycle, the trough, which marks the worst that the economy can get. Eventually the roller coaster starts ticking up once again to kick off the next phase of expansion.
What will Happen to my Investments?
The last recession came in the wake of a subprime mortgage crisis. The one before that came from the dot-com bust followed by 9/11. Both of these brought down the stock market for a period of time. Right now it’s the Coronavirus causing the markets to be exceptionally volatile.
From a monetary and fiscal stimulus standpoint, the Federal Reserve’s response – using experience, hindsight, and referencing the 2008 financial playbook – has taken proactive measures to ensure the banking system remains healthy. The end goal is that we never relive the credit/liquidity crisis that took our financial system to the brink in 2008. So far, so good.
The Fed engaged in aggressive rate-cutting and launched a massive $700 billion QE program. It has also dropped interest rates by a total of 1.5% bringing them to their lowest level .25% – .50% It’s nearly impossible to imagine a scenario where banks do not have access to ample liquidity.
To be clear on my views right now, the economic impact from supply and demand disruptions will result in negative growth for Q2 and cause a recession. Couple this with the emotional response to uncertainties surrounding the pandemic, and it is very normal for stock prices to be heading lower. I expect more market volatility in the coming weeks, but I also firmly believe that if your financial goals and objectives have not changed, then your portfolio allocation should not change either.
What’s good to remember is that investing in the stock market is made for the long haul. The best thing you can do is weather the storm. Expect that the market will drastically fluctuate and leave your money where it is. If you’re closer to retirement and need your money sooner, you could put it away in a high-yield savings account. But even those are experiencing interest rate drops.
The history of financial crises and recessions very clearly shows that the best course of action is to continue to hold equities through the recession as opposed to trying to time the market. An investor will make more money holding equities through a bear market than trying to time the bear market, in my view.
I still very much view the current downside risk as event-driven – not as a systemic risk that will lead to a financial crisis. Governments and central banks are intervening to stabilize the economy and capital markets; the severity of the outbreak in China is abating quickly (signaling it can be contained), and the banking sector is very well capitalized. In my view, this looks and feels more like September 11, 2001 than it does the 2008 financial crisis.
In both of those cases, the public experienced shock, confusion, and anxiety in the absence of information available to make rational evaluations. It takes time, but the information will come, the crisis will abate, and the markets will recover. As it has been the case with almost every historical bear market – if you do not have to sell for liquidity reasons, the best course of action is to hold through a bear market. If you have cash on the sidelines – buying now is not necessarily a bad idea, in my view.
The issue is that there is no way to know when the market will stage its strong recovery, though history does tell us that it usually happens in close proximity to the scariest down days.
Here’s a key stat to remember: over the last 20 years, 24 of the 25 worst trading days were within one month of the 25 best trading days. This speaks to the perils of trying to time exit and entry points during heightened volatility like we’re seeing right now. Doing so means potentially – if not probably – missing out on the market’s best rallies that every equity investor needs to drive long-term investing success.
So stay on course, and remember, this bear market will be followed by a bull market!