Recession concerns weigh on many investors’ minds, but in many ways the economy is doing okay. This may sound crazy, given market declines this year, but it is a good time to remember that the economy and the markets are not the same.
The stock and bond markets are price-setting mechanisms. The prices are set by the aggregation of countless pieces of information, all influencing investor behavior. Over the last 20 years, the pace of information flow has greatly increased. More information, more quickly, means more rapid price adjustments as investors decide what to do about what they learn.
Recently, the markets have started to price in a higher level of risk, hence the declines in bonds and stocks. It started with more-persistent-than-expected inflation leading to aggressive federal reserve action. Investors have taken that information and acted swiftly, to the point that we feel that most damage in the bond market is behind us. The health of the bond market is strong, meaning there is not significant default risk and the financial system itself is not in any systemic danger, a la 2008.
Stock investors see the Fed action and worry that it will kill demand for goods and services by making it harder to borrow money for things like cars and houses. The market declines may be overstating that case, as there is considerable momentum remaining. Employment remains very tight and wage growth is up. Much of the price inflation is because demand for goods and services exceeding supply.
The pandemic is still the driving force behind all of this. Initial, helpful stimulus was followed by excessive stimulus, including too-long loan forbearance programs for many people who didn’t need it.
The Fed may go too far, and we won’t actually know if we are in a recession until it is already part-way through. But it is not a foregone conclusion that we are in one or likely to enter one this year.
Your personal situation continues to be the most important factor to consider. Are you in a recession-sensitive job? How sensitive is your income to interest rate-related factors? Increasing your level of savings may be appropriate.
Changing the investment mix of long-term investment programs is not recommended, as these declines are the best opportunity to acquire shares at lower prices. In the meantime, interest and dividends from existing holdings are reinvested, providing an additional benefit while we wait for improvement.