It's a topic that has been on everyone's mind: Is a recession coming, or are we already in a recession economy?
And it's a tough question to answer.
Recession fears, stoked by post-pandemic economy activity, high inflation, rising interest rates, political instability, and overall economic anxiety are incredibly natural given the current climate of uncertainty. There's a lot going on that affects the financial markets (and our lives). When you consider that recessions are part of the general 10–20-year business cycle and that the last major recession was the Great Recession between 2007-2009, the United States seems on track for an economic slowdown.
The problem for many savvy investors and dedicated savers is that no one recession is identical. At the same time, those who can prepare for an economic downturn are more likely to preserve more of their capital in the long term.
While every financial situation is different, here is what we know on a high level about the current state of the economy and how consumers can prepare for a potential economic downturn.
Is a recession coming?
There are two major schools of thought on this at the moment:
- We are already in a recession.
- We are bound to experience a recession within the next one or two years.
Those who believe we are already in a global recession cite economic slowdown, a decrease in consumer demand, and a decline in the nation's gross domestic product (GDP).
However, others suggest that reduced consumer spending is due to high inflation. While the Federal Reserve's decision to raise interest rates adds economic pressures, the goal of these increases is to tame and lower inflation. If successful and inflationary pressures fall, we could see the return of consumer spending.
That said, many economic models say that the likelihood of an economic recession is now doubled, standing at 60%. At the same time, institutional funds like GMO have suggested that we are in a superbubble. Overvaluation of several financial markets—including stocks, equities, housing, and bonds.
What does a recession economy look like?
Instead of giving into recession fears, it's important to recognize potential indicators of an economic downturn. Some common threads among different economic slowdowns include:
- Sustained price increases, either due to shortages or inflation
- High unemployment
- Consumer pessimism about economic activity
- Corrections of overvalued financial markets
- Lack of access to capital
- Low or insufficient wages to allow for spending
The fact is there are numerous potential causes for an economic recession—including recession fears themselves. When investors pull out of an economy, and consumers, fearing the worst, stop spending, the simple fear of a downturn can result in a real economic slowdown.
What is the difference between a recession and a depression?
There are a few key differences between an economic recession and a depression:
- Recessions usually last 1-3 years, while depressions last longer.
- Economically depressed countries may experience 10% annual GDP drops or higher.
- Depressions experience drops in productivity, and recessions do not necessarily experience this.
- Depressed areas experience low inflation or deflation.
In times of high inflation, lowering prices, known as deflation, sounds appealing. However, deflation can harm economic growth just as much as inflation, resulting in lower prices, wages, and consumer spending.
Financial strategy in a recession economy
At the end of the day, just knowing whether we are suffering from a global recession isn't enough. We also need to know how to preserve our wealth and stay afloat during difficult times.
Ideally, you will have a financial advisor you trust, and a financial plan that includes how to invest and save in a worst-case scenario. If not, here are some ideas from my 40 years in the industry:
How much money should you have saved for a recession?
Most commentators say you should have between 3-6 months in an easy-to-use emergency fund. But this will depend on many factors, including the cost of living, your current ability to save, the industry you work in, and potential debts.
Considering that a recession can last up to three years, I would suggest having 9-12 months in accessible savings incase you face unemployment or an unexpected expense.
In facing rising inflation, consumers will also see higher interest rates. This means banks and other lenders will raise their requirements for tapping into credit and will offer a higher interest rate, even if you have a stellar credit score. Having a well-padded emergency fund and low debt is ideal.
What's the best investing strategy to have during a recession?
An economic slowdown shouldn't translate into a complete halt in investing, particularly if you are saving for retirement. Studies have shown that time in the market is more important than timing the market, and it's possible to find sound investment opportunities during this time. Since previously overvalued stock, equities, and other investments typically course correct and drop their price, it can be a chance to scoop up assets that will gain value in the long-term.
Every portfolio is different, but it's common for clients to focus on:
- High-dividend yielding stocks and indices with strong balance sheets
- Precious metals and other inflation-resistant commodities
- Stocks with low debt in core sectors
- Once higher interest rates stabilize, short and medium-term bonds can be a good fixed-income option.
- Non-US ETFs and funds that are currently undervalued. GMO recommends looking into Japanese funds.
Given the current state of the real estate market, it's unlikely to be a sound investment choice until there's another housing crash. Ultimately, this is a time to be more strategic with your financial planning and asset purchases, and you should always have access to liquid cash in an emergency.
Do recessions have a silver lining?
One of the common causes of a recession, including the Great Recession, is the overvaluation of certain assets. Whether it's the stock market or a housing bubble, consumers can lose money when purchasing these investments at inflated prices.
A recession helps correct this misalignment, making previously cost-prohibitive investments more affordable. This may also aid in taming inflation, even as credit becomes more expensive.
While there are many other hardships during this time, a recession is a short-term challenge, so long as it does not evolve into a total economic depression. Theoretically, the economy should begin to recover after 2-5 years—if you can wait it out, you’re in the clear.
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