What Have We Learned from Past Recessions?

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Most of us were not around for the “Great Depression,” but no doubt we’ve learned a great deal about its impact. We’ve also lived through subsequent recessions with equally lasting effects. So, what do past recessions have in common? And, can we use past red herrons to predict future recessions? Let’s take a look at the similarities:

1. Past recessions have been preceded by periods of high debt
   Prior to the Great Recession, household debt was at an all-time high, which may seem eerily similar to American finances leading up to the 2008 financial crisis. More recently, debt levels in the US are on the rise, recently topping $1 trillion. Once debt becomes unsustainable for most people, according to Jill Gonzalez, an analyst at WalletHub, we might be well on our way into a recession.
2. Asset Bubbles
   Regardless of the asset (housing, stocks, etc) the underlying factors remain the same: low interest rates and easy access to credit. Up until early 2022, interest rates were at a low not seen in 70 years. In 2008, the financial crisis came to a head, mainly due to the Federal Reserve ignoring the risks of having TOO much outstanding credit, and therefore, the amount of subprime mortgage debt became unmanageable.
3. Financial Instability
   In years leading up to the Great Recession, the overall financial system was highly interconnected, which made it extremely vulnerable to shock. Similarly, the current financial system is more interconnected than many of us were aware, as we’ve seen with the fall of large banks in 2008, and small banks recently in 2023. The collapse of Silicon Valley Bank was due primarily to a lack of diversification within their long-term investment vehicles. While fixed income tends to outperform equities and short-term investments through a recession, the “all your eggs in one basket” approach increases risk regardless of the asset.

By looking at the similarities that may signal a recession, are we are headed towards one in 2023?
Possibly. However, there is one glaring difference: the Federal Reserve is much more prepared to deal with a recession than they were in the past. The Fed’s failure to prevent the 2008 financial crisis had a lasting impact on the economy, and Americans had a front row seat to watching the Fed juggle their limited tools in order to mitigate the crisis. In 2008, the Fed acted too late by buying assets and raising interest rates, but the damage had already been done. More recently, it seems the Fed has been ahead of the 8-ball by aggressively raising interest rates and preparing to use other tools as needed. Many analysts might perceive this move as extremely aggressive, but it’s evident that the rise in interest rates has been relatively successful up to this point in warding off a recession. Are we just kicking the can down the road? We’ll cover a few red herons below.
While recessions have had catastrophic effects on the economy as a whole – high unemployment, loss of housing, high rates of debt – there has been just as equally impactful legislation following each recessionary period that has supported the economy even to this day.
After the Great Recession, FDR signed The New Deal in action, which gave way to Social Security, Medicare, Securities and Exchange Commission, and more. After 2008, the Dodd-Frank act became the most far-reaching Wall Street reform in history.

Warning signs of an imminent recession: 

• Spike in credit delinquencies
• A rise in unemployment
• Sharp decrease in consumer discretionary spending

How can a portfolio be positioned defensively in a recession? 

Over the past 50 years, fixed income investments have outperformed equities during every recession. In the 2008 financial crisis, for example, the S&P 500 index fell by 57%, while the Barclays Aggregate Bond Index, which tracks the performance of investment-grade bonds, fell by just 11%. Of course, there is no guarantee that fixed income investments will continue to outperform equities during future recessions. However, history suggests that fixed income investments can be a valuable asset class to hold during times of economic uncertainty. The reason for fixed income bearing less of the brunt mostly has to do with their decreased volatility. Central banks often cut interest rates during recessionary periods, and therefore, lower bond yields become more attractive.

If you are concerned about the stock market, you may want to consider taking some steps to protect your portfolio. 

For example, you may want to invest in assets that are less volatile than stocks, such as bonds or gold. Invest in bonds with a wide range of maturities to help reduce your risk to fluctuating interest rates. Lastly, rebalancing regularly will prevent any blindsides to market swings. At Eamon, we pride ourselves in focusing on a disciplined, long-term approach. It is important to remember that the stock market is a long-term investment. As such, it is important to stay focused on the long-term and not get too caught up in the short-term volatility. The stock market has always recovered from past recessions, and it is likely to recover from any future recessions as well.

If you have questions about how “recession-proof” your investments are feel free to reach out with questions or to have a conversation.

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