Growing pressure on the economy, supply chain and continuing pandemic-related hiring issues are all contributing to inflation. Many of us are advising our clients to prepare for a likely recession. Some predictions are more dire than others, JPMorgan Chase CEO Jamie Dimon earlier this month at a financial conference told investors to “brace for an economic hurricane.”[1]
We are all experiencing sticker shock and it’s real. According to Fortune, the consumer price index (CPI)—which tracks a wide range of goods and services used by the average American including food, energy, and housing—jumped 8.6% over the past year, according to May data from the Bureau of Labor Statistics (BLS). Despite prices leveling off a bit in April, inflation made the largest 12-month jump in May since December 1981.[2]
Recessions can be painful to weather, but they are a necessary business cycle which our country has experienced 19 times throughout in U.S. history, with three in the 21st century (2001, 2008-2009 and 2020) according to the National Bureau of Economic Research.[3]
Characterized by fluctuations in unemployment, sales, manufacturing and gross domestic product (GDP) that occur in a recession, we advise clients to look at discretionary spending or having cash on hand before a recession hits, instead of changing their long-term investment strategy.
What is a recession?
A recession is defined as a decline in economic activity which usually lasts more than a few months. Some of the features that cause a recession are when the economy has negative GDP, higher levels of unemployment and falling retail sales.
Investors are understandably concerned about a recessionary impact on their 401(k). We counsel our clients that if the market is volatile, they may also experience some instability, but staying diversified is important to ride out the storm.
We caution our clients to continue to follow their financial plan and remember, just because a certain sector might be down doesn’t mean they want to remove that sector completely. If they prefer, investors can back off a little in a certain area but when those sectors do bounce back, this will help to make sure they already have exposure and aren’t late to the party!
Overall, our advice it to not overreact! By continuing to make steady contributions every month or every other week, clients are Demon dollar-cost-averaging and buying at those dips. According to the Balance, the idea of dollar-cost averaging is that you buy shares at higher prices when the economy is strong, and lower prices during a recession.[4]
Lastly, don’t try to time the market during a recession. This is costly, is rarely successful and can often result in losses.
Here are additional tips we are sharing with clients on how to help hedge inflation by looking at different asset classes like bonds, commodities or real estate to help diversify.
Find new places to invest:
One idea that has gotten a lot of traction at the moment is I bonds, which are backed by the U.S. government, An I bond is a savings bond that earns interest based on combining a fixed rate and an inflation rate. The inflation rate is set twice a year. Right now, bonds issued from May ’22 – Oct ’22 have a combined rate of 9.62%.
You’ll pay federal income tax up to a maximum purchase of $10,000 a calendar year. BUT you can use your tax refund to purchase up to an additional $5,000 in paper bonds. but you can also use your refund (up to $5,000). (I Bonds cannot be purchased in a qualified plan). You can cash them after one year and if you cash them before five years, you lose the previous three months of interest. You can only purchase them through tresurydirect.gov (yes, the site is beyond old school).
Things to consider: If a client is a high-net-worth investor it probably isn’t a great fit because of the $10,000 maximum. Also, this is a longer-term strategy, as it doesn’t offer immediate returns.
Seek out stable investments that are positively fueled by inflationary conditions:
Clients might consider adding Commodities (raw materials including oil, natural gas, precious metals, wheat corn etc.) to their investment portfolio. Why? As commodity prices increase to help drive inflation in consumer goods, commodity investors can hopefully get a nice return on those investments.
Commodities can be volatile so we recommend investing through a mutual fund or ETF of some sort. Gold is another example of a commodity to keep an eye on. We advise clients in finding a fund that might have a high weighting in gold.
Similar to commodities, Real Estate tends to increase more in inflationary environments. I suggest starting with REITS as a nice way to get exposed real estate investing, because they are through internal funds.
A financial advisor can also find funds that have an exposure to industrial warehouses and apartments and a lower exposure to a lot of office space. Real estate does have liquidity features to it so we never want it to be more than 5% - 10% of an overall portfolio. It can drive a nice income stream.
Stay the Course
Even with the ups and downs in the market, we see some positives. Stick to your long-term plan so you can be prepared to participate in the recovery. Forbes outlines the S&P 500 surprisingly rose an average of 1% during all recession periods since 1945, because markets usually top out before the start of recessions and bottom out before their conclusion.[5]
Staying the course can feel hard but with a financial plan in place, it’s really the best way to continue moving toward your financial goals. While you may hear others who are cutting back on their investments and retirement, if possible, we recommend taking a more prudent approach.
The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual. Asset allocation does not ensure a profit or protect against a loss.
[1] https://www.advisorstream.com/read/forbes/business/what-the-great-recession-teaches-us-about-surviving-the-next-downturn/?c=eyJ0eXAiOiJKV1QiLCJhbGciOiJIUzI1NiJ9.eyJub2RlX2lkIjoxMzAsInByZXZpZXciOnRydWUsImNvbW1faWQiOjU4OTQwNTQsImRlc3RfaWQiOm51bGwsInJlYWRlcl9pZCI6bnVsbH0.2foeJOA2TLpGtdxLdbcSt9RnBjt9VwHz_kIwW2kTAyk
[2] https://fortune.com/2022/06/10/americans-are-cutting-back-on-retirement-savings-and-investments-amid-high-inflation/
[3] https://www.nber.org/business-cycle-dating-procedure-frequently-asked-questions
[4] https://www.thebalance.com/is-it-better-or-worse-to-start-investing-in-a-recession-357892
[5] https://www.forbes.com/sites/sergeiklebnikov/2022/06/02/heres-how-the-stock-market-performs-during-economic-recessions/?sh=8a6d7386852f