By Jim Trujillo
Noise of an impending recession permeated the air waves late this summer when the yield curve inverted for the first time in 13 years. This is understandable, as the curve has inverted 9 times since 1962, and all but two of them led to a recession. (Most recent inversion to be determined). An inverted yield curve is a graphical representation of investors accepting lower yields on longer-term treasuries than shorter-term. By definition, this is an ‘unnatural’ state for the economy as investors typically require a higher interest rate for longer-term investments. Given this key economic indicator, investors are beginning to question their investment strategy. But first things first.
What is a recession?
Economists monitor a variety of economic indicators when evaluating a recession, but the most widely accepted definition is a negative GDP Growth rate for two consecutive quarters. GDP, a nation’s Gross Domestic Product, is the market value of all final goods and services produced. Expanding countries have a positive GDP and a shrinking GDP is indicative of a country’s economy slowing down. You may have heard the phrase “what goes up, must come down”. The business cycle, and the expansion of an economy followed by a recession, is completely natural.
What does this have to do with the market?
In general, the market is a reflection of economic conditions, but the timing isn’t always perfect. As the economy contracts, companies will make less profit, experience less appreciation in the stock price, and distribute less dividends. But many other factors like consumer confidence, individual sector performance and politics also affect the market. In general, a sustained contraction of the economy would most likely be reflected in the market; however, short-term spikes or corrections may not correlate (compare) with the current economic environment.
What about my investment portfolio?
Investors should be cognizant of diversification*. When we reference the ‘market’ above, in relation to America’s GDP and economic outlook, we are talking about one asset class – the domestic stock market. Truly diversified portfolios are comprised of many asset classes that may react differently. In fact, this is the primary reason advisors generally recommend a diversified portfolio. While proper diversification cannot ensure a profit – or protect against a loss – diversification is one of the primary ways we mitigate risk in a portfolio. The idea is your investments should not be too concentrated in one asset class. One common example of this is the ‘flight to safety’. When investors become concerned about the domestic stock market, they flock to U.S. Government Bonds, a widely recognized safer asset class. In 2008 US Fixed Income was the number one performing asset class with an annual return of 5.24%.
What should I do about my 401k?
- Re-Evaluate Your Risk Profile – Speak with an advisor about your asset allocation. How much of your portfolio is allocated to equities versus fixed income? Is the account invested too aggressively given your goals and time horizon? Now is the time, prior to any major market corrections, to make sure you are invested appropriately.
- Don’t Try to Time the Market – Once you determine you are invested appropriate for your risk tolerance, stay the course. The primary rule of finance is ‘buy low and sell high’. It makes perfect sense in theory but can be very hard to actually practice. Investors don’t want to sell their outperforming funds and buy more of the underperformers. A paper published by Willis Investment Counsel late last year found that investors lose 1-2% annually by attempting to time the market.
- Don’t Stop or Lower Your Contributions – If you are regularly investing in a 401k, you are a ‘buyer’. While a down market can be scary, your contributions are going further. A $200 contribution in a down market may buy more share than in an up market. It’s almost like shopping during a sale!
- Set Up Auto-Rebalancing – Most retirement plan platforms allow you to auto-rebalance your portfolio. Once you establish your desired investment allocation, this is a great way to regularly rebalance back to your original plan. Most investment professionals recommend rebalancing the portfolio once or twice a year. Occasionally, a quarterly rebalance is recommending during a particularly volatile market cycle.
If we’ve said it once, we’ll say it again, stay the course! It is natural to feel uncertain during market swings. Now is the time, prior to any major sustained corrections, to review your investment strategy with your advisor or CFP® Professional. Then resist the behavioral temptation to make changes during a market correction.
Jim Trujillo
Financial Advisor at ARGI
JimTrujillo@argi.net