Thanks for coming back for the latest edition of Planning for your Purpose; Telos Financial’s blog where I discuss different topics related to financial planning. Dennis LaVoy is a CERTIFIED FINANCIAL PLANNER™ professional based in Plymouth, Michigan and is Detroit’s financial advisor for high income young professionals serving clients throughout southeast Michigan as well as across the country.
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When will the next recession start?
No one knows. No one. Not that guy on TV. Not that lady who wrote that article. Certainly not me.
There are ways to formulate estimates, guesses, and prognostications, but no one knows exactly. We can make educated guesses to help anticipate and react, but there’s not a way to be accurate about it.
I maintain that the best way to plan for a recession is to have a financial plan and work it. Keep it current and make sure your goals and needs are as realistic as possible so you can invest according to that, not trying to guess what’s going to happen with the markets or economy.
Regardless of what’s going on with markets, the economy, and the news cycle, there’s always something to be nervous about. Recessions. Market crashes. Political uncertainty. International tensions. The national debt. I’m sure you’ve can name a few others too. . .
Recessions are a normal part of the economic cycle. They don’t mean squat for the markets, but their symptoms do tend to be felt in the markets. Rising unemployment, companies struggling, lower earnings, etc. all will be felt in the market and are symptoms of a recession. So, you see, there are some similarities, but again, they are not the same and a bad market does not mean a recession and a recession does not mean a bad market.
What does a recession mean for my investments?
First thing to remember is the economy is not the market and the markets are not the economy. There will be correlations, but they are not perfect. Historically, recessions will start a few months after a market drop starts and the same with recoveries. Remember, markets are much more nimble than the economy and are quicker to anticipate, react, and overreact.
If you have a financial plan, a recession should bear little on the long term. Markets and economies go up and down and a financial plan should factor that in. Your portfolio management should be based on your needs and wants, rather than trying to guess what the market will do.
Buy low, sell high
It’s that simple, but you can’t time the markets. Timing is a losing strategy and you should avoid it. You need to allocate your portfolio accordingly based on your risk tolerance and needs.
Can we time recessions?
While we can’t time the markets, there are some statistics that indicate a recession may be coming. So, it’s certainly not perfectly, but we can monitor indicators and as they begin to point toward recession, we could take actions to mitigate some of that risk if it was a priority.
Historically, if your time and risk tolerance allow, you may be best to stay invested through any downturn. Many reasons, but because market timing is a losing strategy, you’ll most likely get it wrong and that would have worse ramifications for your investments than trying to sell at the exact top and buy at the exact bottom.
What are some signs a recession is coming?
None of these are perfect, but there are many indicators that signal recessions. Many economists have a Leading Economic Indicator (LEI) metric to measure and signal choppy waters on the horizon. You can pick and choose whose indicators you like, but the Conference Board is a think tank that publishes a LEI guide that is widely accepted and it’s a group of ten items:
- Average weekly hours manufacturing
- Average weekly claims for unemployment insurance
- Manufacturers new orders, consumer goods and materials
- ISM® Index of new orders
- Manufacturers new orders, non defense capital goods excluding aircraft
- Building permits
- Stock prices
- Leading Credit Index™
- Interest rate spread
- Average consumer expectations
There’s a lot to unpack there, but I’ll talk about a few of these and some other leading economic indicators in a little more depth.
Interest Rate Spread
Also known as the yield curve. This is a comparison of short term and long term interest rates and everything in between. In a normal interest rate environment, investors are rewarded with higher interest rates for buying longer term bonds. So, the longer the time you are required to stay invested, the more interest you are paid. The shorter the time, the lower the interest rate.
That’s the normal environment and is referred to as a normal curve. If the curve is negative, where short term rates are higher than long term, that is an inverted yield curve.
Every time in the past the yield curve has inverted a recession has followed. Every. Single. Time. To be specific, that is when the two year yield is higher than the ten year. Clearly, there are time frames and yields in the middle that give some information, but it’s not as clear as the two versus ten.
On average, it has been 15.7 months from when the curve inverts to when a recession begins. Obviously, there have been longer and shorter times, but it’s something to consider.
Leading Economic Indicator
As I mentioned earlier, this overall metric put together by the Conference Board also is a metric in itself. When the overall index declines by one percent over a year, that is an indicator of a recession and on average, has been 4.1 months from when this decline is measured, to when the recession starts.
Declining Corporate Profits
Another one not on the list, but when corporate profits fall from their peak, it has been an average of 26.2 months to when a recession begins. As I write this blog, we may have already started the clock on this measure, but profits may go back up, so we might not know until it’s too late.
Keep in mind
These are not perfect. One doesn’t mean anything in a vacuum and while history rhymes, it isn’t a carbon copy of the past. If we start to see several of the indicators moving the same direction, it’s safer to assume things are headed south.
To sum up, it’s impossible to time the markets and it’s generally a waste to try and do so. Rather than gambling with market timing, you should work with a financial planner to craft a custom plan for your family and follow it as a guide for your investment decisions.
If you’d like to create a financial plan to give you confidence you can navigate a market dip, contact CERTIFIED FINANCIAL PLANNER™ professional Dennis LaVoy today at 734-468-3050 or email at email@example.com.
Telos Financial is the financial advisor in Michigan for high income and high net worth Generation X, Millennials, Xennials, & young professionals. It is a fee based, holistic financial planning firm located in Plymouth, Michigan serving young professionals and families. Dennis LaVoy, CFP®, CLU® founded Telos to provide financial planning uses his experience, knowledge, and expertise to help families and individuals in Ann Arbor, Detroit, and across the country achieve their financial objectives.
The views expressed are my own opinions and do not apply to every situation. Your situation may vary so make sure to consult a professional for advice prior to making any decisions.