Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 305

Recession and why timing markets doesn't pay

When do we know for certain that we are on a path toward recession and that what we are experiencing is not simply a reversion to trend? How can investors prepare? Those questions captured the minds and emotions of investors and pundits alike through the first quarter of 2019.

While some of the global economic data released in Q1 was disappointing, we are not put off. The theme of Vanguard’s 2019 outlook was ‘down, but not out’ as we anticipated some deterioration in economic growth indicators. Holding that view is easier said than done when consumption, income, housing, and manufacturing indicators in several nations signal weakness. Almost in spite of the uncertainty, however, share markets in Australia and overseas returned over 10% for the first quarter.

The yield curve and central banks

It was hard – even for the most steadfast of investors – to ignore the debate around the economic cycle once the US Treasury yield curve briefly inverted in the final weeks of March 2019. When short-term interest rates are higher than long term rates, investors become pessimistic about what could happen in the next year, yet optimistic when looking five to ten years into the future. Traditionally, this pattern has preceded every major US recession in recent memory, so quite understandably, investors are taking these warning signs seriously.

Central banks only added to the feeling that economic storm clouds are gathering. Ironically, their actions might have been intended to instill confidence in their respective economies, but markets, especially bond markets, had none of it. The US Federal Reserve revised its vaunted ‘dot plot’ to suggest that interest rates would be on hold for the rest of the year; they had previously signalled two more hikes. Locally, the Reserve Bank of Australia became more tentative in its official policy communications. Even the Reserve Bank of New Zealand changed its tune and openly discussed the possibility of a rate cut.

Investors are now asking; “What do the banks know that we don’t?”

Economic and market outlook

This questioning comes at a precarious time for the global economy, as we recently passed the 10-year mark from the onset of the Global Financial Crisis. Those who say the US economic expansion must end soon, simply because the expansion has been remarkably long, overlook Australia’s record-setting recession-free expansion in their review of the global economy. Investors feel that we are close to crossing a line, albeit a blurry one, between economic growth reverting to trend (2% in the US, 2–3% in Australia) and an outright global slowdown.

Part of this concern is driven from a tightening of financial conditions. According to our analysis, financial conditions and heightened anxiety over economic policy probably contributed to some of the decline in US GDP growth for the last quarter of 2018. In a recent research note, Known unknowns: Uncertainty, volatility, and the odds of recession, we estimated that these shocks could have subtracted as much as 0.4% from 2019 GDP growth.

Inevitably, with each new development in this cycle, we are asked by investors what they can do to prepare. Regular readers of Vanguard’s commentary will not be surprised by our answer: revisit asset allocation, diversify, and review active risks in your portfolio.

Market timing does not pay

Attempting to time markets can backfire and lead to long term underperformance, as our analysis shows in the figure and table below. The questions investors ought to be asking are: ‘If a recession occurs, how should I respond?’, ‘Am I adequately prepared?’ and, ‘Does my financial plan reflect my comfort with uncertainty?’ rather than ‘When will the next recession occur?’

Adequate preparation, whether increased savings, a new asset allocation, or even a conversation between an adviser and their client, is the best way to prepare. The market will take us for a ride as it tries to guess (with limited success) what will happen in 2019. If we stay calm and adhere to a long-term approach, we limit the effect of the market’s fits and tantrums on our journey toward investment success.

Matthew Tufano is an Economist at Vanguard Australia, a sponsor of Cuffelinks. This article is for general information purposes only and does not consider the circumstances of any individual.

For more articles and papers from Vanguard Investments Australia, please click here.

RELATED ARTICLES

From macro to micro: end-of-cycle investing

What does the shape of the yield curve tell us?

Investors need to allow for future cycles

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Latest Updates

Superannuation

'It’s your money' schemes transfer super from young to old

Policy proposals allow young people to access their super for a home bought from older people who put the money back into super. It helps some first buyers into a home earlier but it may push up prices.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.

Superannuation

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Shares

Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.

Economy

Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.