Catch 2022: Insights for a potential recession

Much like preceding years, 2022 has been truly unprecedented. The ripple effects of the COVID-19 pandemic are still spawning uncertainty and volatility as we finish out the year, and investors of all kinds are feeling the heat. Every single asset class is down this year, and while some inflationary pressures are beginning to ease, others show no end in sight.

In our last Thirdly presentation of the year, we dove deep into these shifting factors and examined our yearlong investment strategy with the benefit of hindsight.

2022 proved it’s essential to stay disciplined

This year, our core investment philosophy was put to the test – working to protect against major losses, despite a significantly down market overall. It was a year to redouble our focus on the factors we can control (risk, cost, time and behavior), taking defensive action when needed.

Investors in the accumulation phase (buy and hold investors) had their patience tested as well. History proves that the market tends to trend upward with time, so a methodical approach is wise for these investors, but the interim years can be rough for the risk averse. For investors in the wealth maintenance phase, our blended investment strategy helped protect against the worst potential losses and enabled our clients to maintain their lifestyles.

One unusual aspect of 2022 was that bonds fell, despite traditionally being resilient to recessionary pressures. While bonds broadly did suffer some historically high losses in 2022, this outcome was superior to the broad stock market, which confirms that being defensive this year was the right choice, even though we ended up with a less favorable outcome than our data suggested.

So, is recession on the horizon? That’s the multi-billion-dollar question. There is a chance that recession could be avoided, but not a big enough chance to count on, in our opinion. Financial conditions are tightening, interest rates are rising, and it’s becoming increasingly difficult to borrow money, which is likely to drive down profit margins. It’s safer to expect a recession is coming and plan accordingly.

4 steps to prepare for a recession

A recession is defined as a period of temporary economic decline and reduced trade and industrial activity. The three essential characteristics of a recession are:

• Two negative quarters of GDP growth in a row.
• ISM Manufacturing Index below 50.
• PMI Services Index below 50.

While the factors that could cause a recession are far outside our control, we can control our behavior now to protect against some of the effects. Start with these four steps:

1. Delay large expenditures (if you can). It sounds like financial advice 101, but it bears repeating: Now is a great time to spend less money. Of course, life happens and sometimes a big expense is unavoidable. But it’s worth looking ahead to your plans for 2023 and considering what could be postponed.
2. Do an in-depth budget review. While it’s nobody’s favorite task, it’s absolutely essential to take stock of your budget at least once a year. Look for opportunities to downsize or consolidate – and watch for increasing prices on auto-pays that you may have forgotten about. Keeping a close eye on expenses, and keeping your records accurate, will help prevent budget creep.
3. Make a habit of shopping home and auto insurance. Every three years, start comparison shopping for introductory offers or competitive packages from other home and auto insurance carriers. (Don’t do it more often than every three years, or companies will flag you as a “switcher” and decline to offer introductory rates.) You might also consider working with an insurance broker, who can compare multiple carriers, rather than a captive agent offering only one company’s products.
4. Increase portfolio contributions if possible. If you can implement one or more of the previous steps and it leaves you with some extra cash, put that back into your portfolio – especially if you’re in the accumulation phase of your investment journey. The best time to buy usually is when the market is down (buy low, sell high).

With some forethought and discipline, we can set ourselves up to weather a downturn, and even see some benefit in the long run.

Assessing the current market

2022 was an anomaly year for asset price drawdowns with the majority of investable assets seeing significant losses. This is unusual as diversification, a long-held staple of investment advice, traditionally adds protection from drawdowns that do not typically impact almost every asset simultaneously. While a typical year for the broad bond market shows intra-year declines of around 3 percent, this year’s worst drawdown was closer to 17 percent and bonds are typically considered the “safe” asset class. Sharp sell offs do tend to rebound, so we may see these numbers improve as the end of the year approaches.

Historically, economic recessions are worse during a bear market. They can take much longer to bottom out, and have a longer recovery, than recessions that occur in bull markets – such as the last one we saw in 2020. If we do enter a recession, it’s likely to test our patience. During such uncertain times, a base CWM principle is to remain disciplined and follow the process. That will help make uncomfortable decisions, like potentially taking on greater portfolio risk in the midst of a recessionary market selloff (typically a good long-term time to buy), a more automatic response based on data.

Another major factor holding down assets is Federal Reserve policy and decisions to increase interest rates in response to the highest inflation in 40 years. At CWM, our current positioning sets us up to avoid major losses – and potentially capture some upside – as long as inflationary pressures continue to wain and not prompt further aggressive interest rate responses from the Federal Reserve above those already expected.

Another major factor is consumer spending and the rising use of credit versus savings. This trend is unsustainable, which puts current consumption levels into question. With savings rates low and credit card usage way up the signs point to the U.S. consumer eventually getting tapped out.

Industry and real estate

Increased energy costs in response to the continued conflict in Ukraine pose a major risk to further raise inflation. To alleviate the strain of higher energy costs, the federal government has been tapping into the strategic petroleum reserve to inject millions of barrels a day into the market to keep prices down. The risk here is that the strategic petroleum reserve is finite and reducing that supplementation can potentially raise energy costs even further.

But there’s some good news too. Supply chains are normalizing after the COVID shutdowns, and commodity prices are coming down to 2018 levels. Shipping costs are still higher than they were before the pandemic, but they are significantly lower than they’ve been in the past years. And our favorite metrics to watch, used car prices, are dropping faster than any other time in recent history.

Early in the COIVD-19 pandemic, interest rates plummeted allowing more buyers to participate in the housing market and home prices soared as a result of the lower interest rates. Now, as we see interest rates increase, the demand in the housing market is slowing as buyers cannot as easily afford the high prices of homes. As a result, many homeowners are deciding to delay or avoid selling their homes, which may support the overall housing market in the long run by reducing the available supply of homes for sale.

Looking ahead

If these past years have taught us anything, it’s that nothing is certain. We never claim to know the future, but thoughtful statistical analysis gets us closer to reliable predictions. Our process has been tested thoroughly in 2022, and while the year has been more volatile than we’d hoped for, we did successfully avoid the worst of the losses and are maintaining a solid defensive position moving into the new year.

With discipline, consistency and forethought, we can take some of the uncertainty out of these inherently uncertain times. We at CWM are privileged to serve as your wealth management team in this tumultuous landscape, and we honor your trust in us by working tirelessly to anticipate shifts, seeking to protect against downsides and supporting your goals to live richly.

To discuss your financial goals for 2023, schedule a virtual or in-person meeting with your CWM advisor. Call (425) 778-6160 or complete the form at www.cwmnw.com/request-appointment. We’re always happy to help at Comprehensive Wealth Management.

The market indexes discussed are unmanaged and generally considered representative of their respective markets. Individuals cannot directly invest in unmanaged indexes. Past performance does not guarantee future results. The return and principle value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. No investment strategy can guarantee a profit or protection against loss.