After a brief respite of strong gains in late May, further market falls have dominated media headlines. This has been precipitated by fears of a recession, fears of inflation and the potential for "stagflation" to reappear.
The concept of recession is a familiar one – causing high unemployment, business failures, and bankruptcies as a result of diminished demand from consumers and businesses. While recessions are ideally avoided; they are a necessary by-product of excessive risk taking, money printing and a general disregard for Investing 101 basics.
Markets have experienced periods of slowdowns before; however, a younger generation has largely managed to avoid this pain in their lifetime, in part due to the general desire of politicians and governments nowadays to avoid financial pain at all costs. Their investment experience has been periods of continued growth without significant volatility. Many are now feeling the heat of the concentrated risk they’ve perhaps unknowingly taken by investing in a limited number of securities, such as on share trading platforms or in cryptocurrencies.
Economic slowdowns are a normal part of economic contraction following periods of expansion and therefore there is no need to panic. However, extra care and attention to spending and avoidance of unnecessary risks during these periods becomes more important.
Even during a significant economic downturn, there are many positive steps that can be taken to improve financial situations and measures that can be put in place to ‘recession-proof’ assets. The key, of course, planning for the longer term. Others include measures to ensure job security, taking care in business expansion, borrowing funds, and reviewing cash flow forecasts. From an investment perspective, it’s a good opportunity for asset accumulation at lower prices and certainly not the time to be selling out.
Stagflation (Stagnating growth, and high inflation) on the other hand is another matter. This is when there is an environment of slowing or stagnant economic growth, jobs losses, plus inflation.
Stagflation is rare but can be persistent with devastating effects; in the U.S. it occurred from the 1970s to the early 1980s. Important to note however, that it normally comes with high unemployment which is not the current market scenario. Stagflation is not setting in at this stage and reserve banks around the world are raising interest rates with the goal of countering inflationary pressures. In other words, they are increasing the cost of money reduces your spending power (what you can afford to buy) and therefore effectively making you spend less.
In saying this, similar principles apply to your financial affairs as for a recession; establish a strategic plan, review cash flow forecasts, hold emergency funds where possible, pay down debt, and ensure diversification of investments to weather the storm.
Both scenarios are far more complex than we have discussed, and economists/experts vary widely in their opinions on when, if and how long these economic circumstances may arise. As always, accurate predictions are difficult.
In these circumstances, wisdom is not expressed in panic-selling of investments. While the markets are experiencing some liquidation panic, the reassuring news is that, while these times are uncomfortable, such panics usually don’t last long. History shows that stock gains can add up after big declines as illustrated below. Investors who make continued contributions will benefit from the eventual upside.
With any personal investment strategy, it needs to be fit for the specific purpose and situation of the individual. Long term planning and executing assists in being in the right position when markets recovery to take advantage of the opportunities this presents. Wealth managers are critical in establishing these strategies and assisting in the delivery over a longer-term.
By Glenn Read
Principal Adviser, Director
Date first published: 14 June 2022
Image source: Dimensional Fund Advisors
This article is intended as general information purposes only and is not, nor should be considered, financial advice or recommendations. Where the author expresses opinions, this should not be taken as financial advice for any individual. It should not be used as a substitute for seeking professional financial advice which takes into account your personal financial goals and circumstances.
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