No Two Recessions Are the Same

It’s hard to miss the word “recession” in the media these days. And there are plenty of questions surrounding this topic. Are we in one now? Are we about to be? If we have one, how deep will it be? The reality is that these questions are trying to put certainty around something that’s inherently uncertain: the future. That ambiguity can cause some investors to want to make significant changes to their investment plans as they prepare for what they think a recession may look like. Unfortunately, that is often a mistake. Although recessions are part of the natural business cycle, each one is different. The variability of each downturn raises the risk for investors who may overreact when trying to time the market by making shifts in asset allocations. However, since recessions are a known feature of the economy, they can be planned for over the long term. That’s why having a financial plan that takes a holistic approach to managing risk is so important in rocky times —and is key to long-term financial well-being.   

Not every recession is deep 

For those worried about how the next recession may play out, the temptation can often be to anchor their expectations on recent or significant experiences, and for many, that means the Great Financial Crisis. The crisis was sparked when a bubble in the housing market burst, leading to destabilizing losses for financial institutions worldwide. The impact of the rapid deterioration of the housing market quickly spread throughout the financial system, thanks to loose lending standards in place during the run-up in home prices as well as significant debt levels for both businesses and consumers. The recession lasted 18 months, and unemployment more than doubled from an initial rate of 4.7 percent to a peak of 10.0 percent. 

However, if you look at the history of recessions as a whole, you’ll see that no two economic downturns are the same. As the chart below shows, some recessions are marked by large drops in gross domestic product (GDP), while others — such as the dotcom recession of 2001 — saw a minor 0.6 percent decline in GDP. Likewise, increasing unemployment rates and higher than average inflation are often associated with the start of a recession. However, they aren’t necessarily highly correlated factors of the depth, duration and nature of each recession. And for investors, it can be incredibly difficult to predict the start or end of one with any great precision, much less how to perfectly time portfolio moves in response. 

While no financial advisor can predict the future, they can look to the past for clues about what may be to come. Armed with that knowledge, they can undertake a robust planning process using the Monte Carlo simulation, which examines hundreds of possible paths for the markets. In other words, the potential impact of recessions is reflected in the plan; so, when challenges do arise, it shouldn’t derail you from reaching your financial goals. 

Identifying recessions 

Part of the challenge of making broad generalizations about recessions is the vagueness of how they are defined. The classic definition of a recession is two consecutive quarters of declining real GDP. However, the most widely accepted definition is from the National Bureau of Economic Research, which states a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”  

Regardless of which criteria is used, it is safe to say a recession is an event that typically coincides with widespread weakness in the economy. But this broad definition provides little help when trying to determine how a recession will play out.  

A comprehensive alternative approach 

Instead of shuffling an investment portfolio based on predictions of an unknowable future, we believe a comprehensive financial plan can take the guesswork out of investing and better position you for the inevitable economic bumps in the road ahead. There are any number of other known risks along your journey, from unexpected expenses to the possibility that you or your spouse will be unable to work due to disability. Financial planning is about creating a road map to reach your goals while also addressing the risks that could stand in the way.  

Whether we enter a recession today, tomorrow or in the future, having a plan in place can help guide you through turbulent times in the market and help you stay the course. Focus on your long-term goals instead of getting distracted by the short-term noise in the stock market.  The fact is wealth isn’t generated only when times are good but also by the decisions you make when the markets are under pressure. The ability to remain steadfast and use that opportunity for growth, helping capture the upside when the markets eventually recover, comes from our longstanding commitment to drive value over time — because we’ve seen that playing the long game tends to win, generation after generation.  

Commentary is written to give you an overview of recent market and economic conditions, but it is only our opinion at a point in time and shouldn’t be used as a source to make investment decisions or to try to predict future market performance. To learn more, click here.  

There are a number of risks with investing in the market; if you want to learn more about them and other investment-related terminology and disclosures, click here.