Everybody knows a recession is coming … sometime. Nobody, however, can say with any certainty exactly when.
Thus, for investors, trying to time the market or react quickly once a recession starts is a nearly impossible task. Investment advisers say it’s far better to be prepared with an investment plan that incorporates your risk tolerance prepared by an adviser who can show you what a down market will do to your portfolio and help you adjust ahead of time if you need to.
The Lane Report spoke to investment advisers with Kentucky clientele to get their views on the potential for a recession and how they recommend their clients prepare their portfolios. Here’s some of what they had to say. The conversations have been edited for length and clarity.
Layne Wilkerson
Wilkerson Financial, Frankfort
Lane Report: How are your clients feeling about the markets based on the news they see every day?
Layne Wilkerson: I do have clients who don’t think about it, and that’s what we try to train them to do: Don’t worry about the day-to-day. But the past year or two, it just feels like there’s something new to ponder and people are worried about the tariffs and reactionary policies.
It used to be that things were telegraphed and nuanced and words were carefully considered before being put out by the Federal Reserve or the Treasury secretary or whomever. Now a tweet in the morning can move the market 300 points.
The clients are expressing more concerns about what’s going to happen day to day. But long-term, we’ve been through not necessarily this situation before, but we’ve been through lots of bad situations and the market trend is always up.”
LR: How are you helping your clients prepare for a potential recession?
LW: Most people we work with are either nearing retirement or in retirement, so as part of our plan we’re creating an income strategy or investment strategy.
We always have some funds in cash for their monthly withdrawals or their monthly income expenses, and right now for those who are more conservative we are maybe raising a little bit more cash to fund an extra year of expenses if there is a downturn or recession, which eventually there will be one. For those who are even more conservative, we may raise even more cash. When I say cash, usually that means a money market or CD.
LR: What other advice do you have for investors?
LW: If interest rates continue to fall, if there’s any debt people have that we may be able to refinance and make it cheaper, we’re also looking at that. Particularly since the fall of last year, rates have really dropped quite a bit.
Jeffrey Thomison
Community Trust Wealth &
Trust Management, Lexington
Lane Report: What’s your thinking on a potential recession?
Jeffrey Thomison: It’s been roughly 11 years and counting since the last recession. Over that time frame the stock market has provided investors with over a decade-long bull market. The worst year in that period was last year when the market was down just 6%. Also during those 11 years we’ve had eight years where the stock market produced a double-digit percentage gain.
Having said that, the attention statement would be that we’re fairly certain a recession will occur at some point in the future. They really are a natural part of the business cycle but not necessarily to be feared. Extra anxiety currently exists because of the severity of the most recent recession.
LR: What other data are you looking at?
JT: Right now there are more positive factors than negative factors: the employment rate, wage growth, consumer confidence, the leading economic indicator mix, housing starts, dividend growth among public companies, the low interest rate environment and GDP.
On the negative side, there is a slowdown not only in our economy but a lot of economies globally. In the U.S., there’s been a noticeable decline in manufacturing and service industry data. And then the whole U.S.-China trade relationship with tariffs and negotiations and so forth creates a lot of uncertainties. Then lastly there’s the 2020 presidential election uncertainties.
LR: How do you approach dealing with clients, many of whom may be nearing the end of their work lives and looking toward retirement, for the potential that they could see a more volatile period and with larger downsides?
JT: It goes back to the hallmarks of portfolio management and that is two things, primarily. One is, you tend to lower the exposure to the so-called risk assets – primarily the stock market – as one ages. The other thing would be continue to diversify among the major asset classes – stocks, bonds and cash, so to speak – and also diversify within those asset classes.
The stock market tends to emerge from recessions in robust fashion. The 18-month periods after recessions end have historically been some of the strongest stock market conditions in history. I believe it’s overly aggressive to try to time the market. I think it makes more sense to reduce equity exposures in moderation based on one’s risk tolerances. That’s different from trying to time the market with aggressive, large-scale shifts to the portfolio.
Robert Hawkins
Commonwealth Bank & Trust Co., Louisville
Lane Report: What are your thoughts on a potential recession?
Robert Hawkins: We thought there was a higher chance of going into recession probably about two years ago as the Fed was tightening, and lo and behold what ended up happening was the Fed stopped that process and is now easing. We think that kind of puts the chances of a recession beyond 2021.
I think what a lot of people may have missed, or what didn’t get telegraphed by the Fed, is that other (emerging market) economies were cutting their rates, lowering their currencies. That is, I think, a lot of what spurred the Fed to move, because it had a lot of people puzzled with the unemployment numbers. They weren’t really as concerned about the slowdown when the Fed first started signaling this in June but these other currencies were falling, and if the Fed hadn’t moved we could have very quickly seen our currency rise as much as 10%.
LR: Are you sitting down with clients now to discuss planning for a recession?
RH: We started a couple of years before because we saw some writing on the wall with that and with the Fed we were expecting volatility. Now, if we were working our way to a lower-risk allocation, we’ve said we’re going to hold right now and wait. We think there’s equity upside for awhile. But we know we’re going to have to be nimble here, and we may be calling you to downshift. We did the planning and so now the message is more that the plan is good; we’re holding off full implementation if we haven’t worked our way out and in some cases are working our way back into parts of the equity market.
LR: Which parts?
RH: Emerging markets. We started working our way out of emerging markets and now we’ve started working our way back in a little bit more. We’re more tinkering with the mix of what we own.
We’ve always systematically sat down with our clients. We build all our port(folio)s backwards from risk. And we define risk as: In a bear market this is how much your portfolio is going to be down. Are you comfortable with that? If not, we’ll make it less risky and this what the impact will be to the returns. We spend a lot of time educating our clients around that year in and year out.
Brandon Gaines
Northwestern Mutual Wealth Management, Lexington
Lane Report: What do you think the potential is for a recession and how are you working with clients?
Brandon Gaines: We’ve looked at this optimistically. For right now, looking at the underlying U.S. economy, it’s still chugging along. We’re certainly not having that lifeboat drill right now with our clients.
I look at clients being in one of three categories. The first would be people who are more than 10 years away (from retirement or other investment goal). If you’re more than 10 years away from that goal I don’t think (a recession) matters at all. When it happens that’s an opportunity to put money in and buy shares on sale.
If you’re within 10 years … I think it’s a great opportunity right now, while things are still doing well, just to reassess, how much risk should I be taking? And it’s a good time to – if that risk level needs to go down a little bit – maybe reduce some of their equity exposure, to go ahead and do it while things are still remotely positive.
If I have someone within two years of retirement or who maybe is retired, the advice we’re giving them is, number one, they absolutely want to make sure they’re comfortable with the amount of risk they’re taking today because if that changes tomorrow that could affect our plan. Number two, I think it’s really crucial for people who are near retirement or in retirement to have an adequate emergency savings, or at least have some assets that are not correlated to equity markets and know that if their stocks did go down in value for a couple of years they have the ability to deplete savings and live for a couple of years off that cash to allow those markets to be able to come back up.
If a client doesn’t have a financial plan, if they just have accounts and investments but are not really tracking toward a long-term plan, now’s the time to create one.
Mark Holloway
Stock Yards Bank & Trust, Louisville
Lane Report: How are you viewing the economy these days?
Mark Holloway: The outlook for the economy has become more uncertain. There are some stress signs out there. This inverted yield curve is very seldom positive for the economy; the trade war concerns; the last couple of manufacturing reports that we’ve seen were pretty weak and that may be due to a labor shortage as much as anything; and then the age of this economic expansion makes it suspect.
And then the last two things are my two big bugaboos: the amount of public and private debt out there. We’ve got $22 trillion in debt from our own government and, because it’s very close to about the same size as our economy, servicing that debt takes away from the ability to stimulate economic activity. And then the final thing is the Federal Reserve; I think the Federal Reserve has been very politicized by the current administration. They’re going to do everything they can to make sure we don’t have a recession in 2020 during an election year.
LR: What sort of advice are you giving to clients?
MH: We want to make sure that people aren’t falling into the trap of increasing the amount of risk chasing income. I think a lot of people have used common stocks as bond substitutes and haven’t had the impact of the increased volatility that they get from owning more common stocks than they probably should. Another thing that worries us is a lot of people are lowering quality right now on their fixed income (assets) and extending maturities at a time when that doesn’t seem like it’s an appropriate thing to do.
So the first thing we’re doing is we’re talking asset allocation and making sure that people are in the appropriate mix of assets for their time horizon, their tolerance for risk and their income needs. The next thing we’re doing is making sure everyone is very diversified. We want to make sure we’re exposing everybody to all different kinds of securities both on the equity and the FI side so that we’re kind of weaving a safety net under portfolios to some extent.
The other thing we’re doing is we’re concentrating on dividend payers and growers. If I’m right about this capital market outlook and that the return from stocks is going to be lower, it’s going to give you a leg up to have a portion of that return from the certainty of a dividend and a dividend that grows.
We’re staying, on the fixed-income side, very high quality. I think it’s very late in this economic cycle to be lowering quality at a time when you may begin to see some increase in default risks if we’re right about this economy slowing down.
John Cheshire
Asio Capital, Lexington
Lane Report: How do you view the potential for a recession?
John Cheshire: It’s interesting because when I see the news and I talk to clients, everyone’s talking about a recession that’s going to occur. That is typically not the backdrop that you see a recession occurring. Usually recessions kind of sneak up on you and you realize you’re in one afterward. So I’m not convinced that we’re going into recession. Just from the standpoint that everyone says that we’re going to.
However, you are seeing a deceleration in global growth and a peaking of a lot of leading economic indicators. We’re also in the longest expansion that we’ve ever had, but it’s also the weakest expansion we’ve ever had. So if you look at the velocity of the expansion, we’ve gone less far (forward) than the weakest recovery we’ve had. In other words, we haven’t recovered back up to normalized levels, or even close.
We can keep this going for a while. I do think it’s late in the game. I think there certainly is a very strong probability of recession.
We pound the table on (being) neutral; we would be holding some short-term fixed income as a buffer, but overall we are neutral. I don’t see that there’s a compelling case to go to cash and reduce your exposure to risk assets, i.e. stocks, but it’s hard for me to get aggressively bullish here, too.
LR: A lot of people are going to be retiring in the next 10 years. They’re going to be de-risking their portfolios and moving to more conservative investment strategies….
JC: I know where you’re going with that. Here’s the problem: The 10-year Treasury is yielding, what, 1.8%? So you’ve got to pay tax on that, and that’s going to leave you with about 1.4%. And inflation’s 2%, so for 10 years you have a guaranteed loss of almost three-quarters of 1%.
The purpose of fixed-income allocation today is not earning an income or having return; it’s the ability to redeploy it in assets if there were distress. So let’s say the stock market drops by 20%. I’ll have a great day. I’ll have a fantastic month, because I’m going to be able to redeploy my clients’ fixed-income assets into equities at that particular point at a much higher future rate of return. When the stock market goes down, future returns go up; when the stock market goes up, future returns go down. In times of disruption, returns are made by redeploying cash in the disruption.
Michael Antonelli
Baird (formerly Hilliard Lyons),
Milwaukee, Wisc.
Lane Report: What are the chances of a recession?
Michael Antonelli: It’s important to remember that people are very bad at forecasting things like recessions. Recessions are born of lots of things – economic slowdowns, macro shocks, the Fed getting too aggressive. But there are so many inputs that it’s hard to predict it in real time. That being said, we don’t think one is imminent here at Baird. We’re not on recession watch. But that doesn’t mean that we’re not engaging with our clients around the prospects of one.
LR: How does a wealth manager engage with a client about a possible recession?
MA: Preparation matters. When you go to the dentist, you’re doing preventative cleaning to try to avoid problems down the line. It’s the same when a wealth manager engages with a client about a recession. We say, let’s look at a couple of things right now so that if a recession does arrive, we’re better prepared.
The first step is to say, here’s your portfolio, here’s what we have you invested in, here’s what your plan looks like, here’s how it acts in a recession. Some of the worst bear markets are associated with recessions. We know that an economic slowdown in a recession, more than likely a bear market will accompany it. So we say, here’s what your portfolio would do in a 20, 25, 30, 35% decline. If we present that to our client and they say, ‘I can’t handle that, I wouldn’t be able to sleep at night if this is the case,’ then we know right now is a good time to adjust our portfolio.
The second thing we would do is sit with the client and say, in the event of an economic recession, in the event of an economic slowdown and an accompanying bear market, here are my contingencies for your spending. Because looking at investments is only one side of what a wealth manager would do. The other side is managing a client’s spending and their savings rate.
One thing about financial plans, they’re not carved into stone. These are living, breathing things. The best wealth managers acknowledge that they’re living, breathing things and that they be adapted on the fly.
Chris Clair is a correspondent for The Lane Report. He can be reached at [email protected].
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