There are some alarming headlines out there right now. The story reads like this…
There’s a debt bubble, stocks are overvalued, we’re in an unwinnable trade war with China, the Fed is destroying any yield I was getting at my bank, and the inverted yield curve is signaling that we’re headed into a recession.
...and now we’re going to buy Greenland!? Okay, we’re probably not going to buy Greenland, but if it is indeed for sale, I’m in.
It’s a perfectly reasonable time to be asking, what should I do with my investment portfolio? I’ll get to that eventually…but first, know this:
Markets are extremely efficient. Things that are known are always priced into the market.
The stock market is incredibly good at pricing itself. Inefficiencies in price are next to impossible to find. Around 50% of trading volume on the major exchanges is done with high-speed computers that use complex trading algorithms to execute a strategy. Some of these algorithms are designed to understand new information hitting the news cycle and execute trades before anyone else has had the chance to react. It’s well known that there’s an advantage to those computers whose proximity is closer to the exchange, as their shorter distance allows for faster execution.
Just think about that:
We’re talking about computers that read news stories in the blink of an eye, interpret those stories, then place their bets at the speed of light. And in this high-frequency, high-speed trading game, the difference of a few miles at the speed of light is enough to impact the outcome.
That’s how efficient markets are.
The market knows about the inverted yield curve. It knows that we’re in a pickle with China and that stocks are trading at unusually high multiples that have historically not been supported.
It’s not the ‘knowns’ that are concerning. It’s the unknowns that are out there – things that haven’t happened yet that no one can predict.
In 2008, the market knew that there was a subprime debt problem, but no one knew Lehman Brothers would fail and 464 other banks would follow suit, threatening the existence of the global banking system. In 2000, we knew there was a dot-com bubble and productivity was slowing, but we didn’t know about 9/11.
There is no shortage of known reasons for concern right now. Many are especially concerned about the yield curve’s recent inversion because each of the last nine times the yield curve has inverted, a recession has followed, on average, 14 months after inversion. A more sophisticated investor might note that the S&P 500’s CAPE ratio (an equity valuation metric that stands for the cyclically adjusted price/earnings ratio), is at a level only seen twice, both times just before major recessions, suggesting stocks are overvalued.
I don’t take the possibility of a recession lightly. Recessions are painful. Jobs are lost, families are hurt, the financially vulnerable are forgotten, marriages are tested and businesses are destroyed.
It’s a financial advisor’s job to help you plan for a recession at any given moment, so if we’ve done a good job, you’re already positioned with the possibility of a recession in mind.
Financial advisors know that no one has the luxury of knowing when recessions or market declines are coming, so it would be ridiculous to be with a financial advisor who is making significant changes to their client’s portfolios based on this new information.
This said, I fully acknowledge the headwinds we’re facing, and I do not think you should simply look the other way. I agree with the notion that the chances of a recession are higher than they’ve been at other times in history.
You need to check in with your plan. Are you insulated?
If you’re retired or near retirement, you better have enough assets set aside in boring, defensive investments. Consider paying off your house if you haven’t already. Don’t get cute with your bonds which you own to stay wealthy, not get wealthy. Accept their inevitable low returns and don't chase high yields.
If you’re an accumulator of wealth and retirement is far away, your preparedness to get through a recession starts with the foundation of your financial plan - your emergency fund. Check in with your budget and make sure you have enough funds set aside to cover life’s expenses in the event of a financial emergency. If you own company stocks and were planning on using those funds in the next few years, you should consider dialing those positions back.
Use caution when borrowing. Don’t overextend yourself. Be smart about making big purchases. Stay diversified. Continue to own those boring value stocks that have struggled to keep pace with the sexy growth names. Don’t chase the hot sectors, as tempting as it is.
Lastly, understand the risks associated with your investment allocations. Know that if you’re an accumulator and you dedicate 100% of your portfolio to stocks, you’re statistically giving yourself the best chance to grow your money over the long term, but you need to go through the exercise of:
How am I going to react in a really bad stock market?
Do you have the emotional wherewithal to stay the course or are you one who will panic? And if you are one who will panic, perhaps you should consider owning some investment vehicles that offer a smoother ride and help you stay the course.
Keep in mind that buying investments during a down market is a good thing. There’s an old adage that says:
‘You make most of your money during a bear market, it just doesn’t feel like it at the time.’
Put yourself in a position so you can continue your regimented savings plan during an eventual bear market and take advantage of the opportunity.
It’s a lot easier to own risky investments and stay the course through a tough market if you have financial stability. Your financial plan is only as good as its foundation, so don’t neglect the most basic building blocks.
We’re still within 5% of all-time highs and it’s far from too late to make adjustments if needed.