With the Conference Board’s Leading Economic Index suggesting a recession is likely late this year or early next and the Fed continuing to raise interest rates as they did today, many are wondering if they should adjust their portfolios and get more conservative. There is no way to give an answer with 100% certainty, but let me outline a few things for your consideration.
First, as I have always said, protecting large downside can be a key element in long term portfolio growth. This would seem to suggest that the correct answer would be to get more conservative in one’s portfolio. Ultimately, whether stocks actually do decline further, and if so how much they decline, will really determine whether this option is the best at this time.
But here are some reasons that, not knowing the future, getting more conservative may not be the wisest path at this time…
- This would not be a pre-emptive move before a stock market decline. Portfolios have already declined. Yes, one would be protecting further declines if a recession occurs and stocks fall more, but this will not change the portfolio decline to date. However, being more conservative could cause an investor to miss the increase in the stock market which could make up for the losses already experienced faster than in a more conservative portfolio (See numbers 6 and 7 below).
- If a recession does occur, it is likely that it will not be very steep. The labor shortage could possibly make employers hesitant to lay off employees in fear that they may not be able to hire them back. This, along with the lingering pent up consumer demand for goods and services due to the pandemic, could keep a recession from spiraling deeper.
- If inflation has already peaked and starts to decline, the Fed may take its foot off the “interest rate raising accelerator” and a recession may be avoided. And stocks could rise quickly if this happens.
- At this point, stocks are not overvalued and by some measures are either fair valued or a little undervalued. There is not as much room for a future large decline in the market as when stocks were overvalued.
- Stocks tend to be a leading indicator. It is possible that a potential future recession is already priced into the market and we have seen already all or most of the decline.
- Since stocks are a leading indicator, they will rise before things get better. And it is not unusual for them to go up quickly. July so far has been a positive month in the stock market. Could it be this has already started? If one gets conservative, it would be hard to pick a reentry point that would not miss that significant bump up in stock prices.
- Low consumer confidence suggests the market may rise in the next 12 months. The chart below shows low and high points of consumer confidence over the last 51 years and how stocks have performed over the next 12 months.. When consumer confidence hits a low point, stocks have done very well over the next year. As we mentioned in #6 above, the market rose before things got better and consumers felt better. Consumer confidence at the end of June was lower than it has ever been since it began to be measured in 1952. Now it is possible it could go lower, but if June 30 is not the low point, it is not unreasonable to think that we are not far from it.
Due to the reasons above, I think the best course would be to not adjust portfolios to be more conservative at this time. If you would like to discuss this further regarding your portfolio, please click this link to schedule a time for us to talk briefly.