In the wake of recent heightened market volatility, trade war fears, and monetary easing by the Federal Reserve Bank (Fed), many investors are wondering what lies ahead and, in particular, whether a recession is looming.
What constitutes a recession?
Understanding what, exactly, a recession is, provides a good starting point to preparing for what may be on the horizon. Broadly speaking, a recession is a period of economic decline. Many past recessions are traced to higher interest rates induced by the Fed, asset bubbles that burst, such as housing and the dot-com era, or financial instability. While these factors do not currently exist, a period of two consecutive quarters of decline in real (inflation adjusted) GDP would describe a recession. Stock market downturns sometimes foreshadow an economic decline, as investors react quickly to slowing conditions, putting pressure on asset prices. However, despite this logical connection, market declines do not always portend an actual recession. In fact, in 1966, Nobel Prize-winning economist Paul Samuelson famously quipped, “Wall Street indexes predicted nine out of the last five recessions.” Polite sarcasm aside, Samuelson’s point is valid: often markets correct, and the anticipated economic slowdown does not immediately materialize.
Recessions are not all bad
A sustained economic downturn can often be accompanied by increasing unemployment, slumping real estate prices, and declining stock markets. These can be painful. Recessions periodically occur as a normal part of the economic cycle and can play an important role in reducing economic excesses, efficiently allocating investment capital, and spurring innovation. The impact of a recession is typically short- to medium-term, although a prolonged and deep recession can result in a correspondingly long recovery period.
Regardless of the fiscal, economic, and market environment, Klingenstein Fields Advisors (KF Advisors) constantly monitors macro indicators and their potential impact on your portfolio. We utilize a variety of tools to help reduce risk. These include asset allocation (analyzing the exposure to equity) and security selection (analyzing individual companies’ economic sensitivities). Beyond that, we may also consider more specific tools like hedging and options strategies, while carefully weighing the costs versus the benefits of these approaches. As long-term strategic investors, we believe in thoughtful asset allocation that factors in your circumstances, risk preferences, and return goals. In periods of high uncertainty, we also focus more acutely on liquidity profile (to avoid the need to sell, as well as take advantage of attractive buying opportunities when the market is down). We believe this approach provides the best possibility to achieve your objectives.