First quarter 2023 had many interesting messages with plenty of outcomes from global strategists, economists, and portfolio managers. The S&P 500 advanced 7% in the first quarter yet there are concerns about a recession. If you look at what generally happens in times of recession stocks go down, companies struggle to sustain profitability, jobless claims rise due to layoffs, housing prices drop, and the economy slows down. We saw technology companies with heavy layoffs in 2022. In 2023, layoffs have cost tens of thousands of technology workers their jobs spreading to some of the biggest names in tech like Google, Amazon, Microsoft, Yahoo and Zoom. If the markets are up why are there concerns about a recession?
Sometimes the market sends different messages to investors. During the first quarter the top ten S&P 500 stocks represented 90% of the year-to-date return. One reason for concern is the measure of the Purchasing Managers Index (PMI). This measures whether the economy is growing or contracting. If the index is over 50 the economy is growing and if below it is contracting. Over the past three months the PMI has been below 50, which contradicts what the market returns are indicating. Therefore, there is a disconnect for the near-term.
The lingering inflation caused mainly by the over stimulus brought on by the pandemic is beginning to show more signs that we may be in a recession or are heading into a recession. Each recession is different and if we are in a recession this one may be unique given the first quarter results. Even the experts have not reached a consensus on when or if a recession will happen. Fifty-eight percent of the economists still say there’s more than a 50% chance of a downturn in the next 12 months, according to a panel of 48 forecasters surveyed the week of March 27th by the National Association of Business Economics (NABE).[i] That’s about the same as in a December survey. Unfortunately, no one really knows when a recession begins and ends until it is over.
Why do we have recessions?
Recessions are a natural part of the four phases of a business cycle. The four phases are Expansion, Peak, Contraction and Recovery. Many experts believe we are in the late cycle phase but nearing the end of the monetary tightening (rate increases) and entering the Contraction phase as the economy enters a recession. During the Contraction phase we see a decrease in production/output, increase in unemployment, decrease in wages due to less business profitability and decrease in spending. There seems to be somewhat of a split between consumers who have been spending and consumers without discretionary income making it difficult to decipher exactly where we are in the cycle. The underlying data says we are in Contraction and the market seems to be ignoring the data given the market performance. If we are in contraction that would mean we are in or heading into a recession.
How long do recessions last?
The National Bureau of Economic Research shows that between 1854 and 2022 the average recession lasted 17 months. Since 1950 recessions have not lasted very long. Capital Group analysis of 11 cycles (on average they last about 5.5 years) shows recessions have persisted between two and 18 months, with the average spanning about 10 months.[ii] Although recessions are painful for businesses and laid-off individuals, expansions after recession have been powerful. The stock market will often recover before the recession is over.
If you have a short-term mindset the emotions of experiencing a slowdown in the economy can throw your portfolio off-course as business profitability deteriorates and unemployment rises. During this phase of a recession, it feels as if there is no end in sight. However, you need to trust the market, not emotions, for stronger performance over time. How investors react during times of volatility can make or break a long-term investment strategy.
Can I Recession Proof My Portfolio?
There is no such thing as a recession proof portfolio. Just like in any volatile market environment you should always have cash on hand for your everyday needs, understand your risk tolerance, and diversify your asset allocations to allow you to withstand the various business cycles over the long-term.
We have strategically kept bonds in shorter duration and higher quality over the past few years. In 2020 we shifted to higher quality dividend stocks and trimmed our exposure to growth-oriented companies by taking profits. The result is that it lessened volatility during out of favor times.
We know that the past 15 months have been difficult for investors. Recessions are a necessary part of the economic cycle. They can be a silver lining since they provide a reset for the markets. No one can predict when the contraction turns to recovery; we just know that the cycle historically repeats itself. Know that your portfolio is constructed to provide for your immediate needs and provide future opportunities to meet your objectives.
As we move through the phases of the cycle, we are here for you to guide you along the way. We have been through these cycles before and have succeeded. We greatly appreciate your ability to understand the long-term nature of investing even when the short-term can prompt you to second guess. The future remains bright, and we look forward to our next conversation.
Thomas L. Menzel, CFP® Laura Biermann, CFP®President Vice President
[i] USA TODAY, Paul Davidson Feb. 27, 2023
[ii] Capital Group: Guide to recessions, September 15, 2022
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