How to handle fears of recession
Bob Landaas: Kyle, all sorts of indications these days that global growth is slowing. The question I get almost every day is, “Bob, is a recession coming?”
And I’m compelled to tell clients that recessions are brutally difficult to forecast. There are so many variables. Economists have terrible records of forecasting recessions. And, as you know, we’re capable of talking about trend line, and it’s clear that the economy is slowing.
So, I thought it would be an appropriate time to talk about the Efficient Frontier, the 60/40 mix, and how that typically lends itself to 10 years of withdrawals, at a 4% withdrawal from bonds, where you’re just drop dead positive about the stability of that money short-term.
Kyle Tetting: And of course, Bob, it’s so dependent upon what we know over time has been the stability of that fixed income piece. You look at the bond part of your portfolio, and especially when stocks are doing poor, especially when the market is falling, it’s the bond piece that has tended to hold up. And so, when you’re looking for those sources of withdrawal, it’s really the fixed-income piece—that bond piece—that’s so important.
Bob: The average recovery in modern history for a bear market: roughly two years from the peak to the trough, back to the prior peak. The longest recovery in modern history, right when I got out of college, the stock market dropped 48% from the end of ’73 to early ’75. It took a little over six years for the markets to recover.
And even though that’s an outlier, I use that in my practice as a basic rule of thumb. Folks should have at least six years of withdrawals sitting in bonds to tide them over until the markets recover.
Most of our clients have almost 10 years of withdrawals sitting in bonds, so you get to weather the storm, if you will, batten down the hatches some. Most folks ought to make sure that they’ve got plenty of money in bonds to tide them over, at the very least, for at least six years.
Kyle: It’s so important for investors to remember what it is they’re trying to accomplish, remember their objectives and know what it is they need from their portfolio. And so, while you throw out the six-year number on a 4% withdrawal rate, if your withdrawal rate looks different than that 4%, or if your needs look different than that, then certainly your allocation might look a little different.
And yet, there are just certain constraints to how far you want to go towards the equity side, the stock side. And, there are certain constraints towards how conservative you want to be. Because ultimately, you’re giving up a little on risk, or you’re giving up a little on return if you go too far one way or the other.
Bob: And so many investors are tempted to hunker down even more. You know, the easy part’s getting out of the stock market; the hard part’s getting back in. As you’re well aware, stocks normally recover, start to recover, six to nine months before the recession is even over. So you’re not even able to look at any data points to give you the courage of your convictions.
Kyle: And I think that’s the key piece is the challenge for investors is not just timing economic slowdowns but also timing what to do with their portfolio, if that’s what they’re trying to accomplish. And that’s the piece that balance overcomes is the need to try to make decisions, to try to take action.
Because as we know from a number of studies that have been published, investors are just very poor at timing the markets. A) It’s a very difficult thing to do, nearly impossible thing to do. And, and B) the data that you’re relying on is so vast and can be so shifting that it’s just a difficult thing to accomplish.
Bob: Of the eight major sell-off since I started managing money in the mid-‘70s, nobody called four of them: 911, Persian Gulf crisis, the crash in ‘87 and the Arab embargo, right when I got started. So, four out of eight, even the pros didn’t see coming. So, it’s important for people to build balanced portfolios that’ll stand the test of time because, more than likely, you’re just not going to see the next recession coming.
Kyle: And what we know about that, Bob, is that historically you aren’t giving up much return to take on a little bit less risk, to take on a more balanced portfolio. And all you need is the ability to buy yourself a little bit of time to get there, and that’s what balance does.
Bob: I had a conversation recently with a meteorologist that talks about how difficult it is to forecast weather past 24 hours. And he was just going through the litany of all the things you need to pay attention to.
And I told this individual, it’s a spot-on analogy for how difficult it is to forecast recessions. You think of almost 40 developed countries in the world, they’re all moving at different levels of growth. You overlay all of their sine waves, if you will, to try to ascertain direction. Pretty challenging job.
So, we can talk about trend line. We can talk about growth slowing. But it could re-accelerate at a moment’s notice, or it could continue to decline. And it really underscores the need to build balanced portfolios. And know that, short-term, you own bonds for a reason—so that you’re not selling part of your life’s savings at a discount with stocks, to fund your withdrawals.
Bob Landaas is chairman and chief executive officer of Landaas & Company.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
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Recessions: Uncertainty suggests balance, a Money Talk Video with Kyle Tetting
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(initially posted April 12, 2019)