By Rick Newman-Yahoo Finance Senior Columnist
The last nine years have been great for stock investors, with the S&P 500 up 300% since early 2009.
Expect the next nine years to be more turbulent.
Economists don’t think a recession is imminent, but some think the economy could enter a downturn by late 2019 or 2020. And recessions usually trigger a sharp drop in stock values. Recessions since 1945 have lasted 11 months on average, while the average bear market in stocks has lasted 14 months, according to investing firm CFRA. The average price drop in the S&P 500 during a bear market is 33%.
Some investors are starting to anticipate the inevitable bear market. A recent poll of economists by investing giant PIMCO found that “a US recession over the next three to five years has now become consensus—even though markets do not seem to be pricing in this risk.” PIMCO thinks the next recession will be “shallower and longer” than normal, with steep losses in some asset classes and surprising resilience in others.
To help Americans survive the next recession, Yahoo Finance is publishing a series of stories on how to take advantage of good times now to prepare for leaner times coming. No, we’re not rooting for economic hardship, as comeuppance for President Trump, as some of his backers may believe. We’re simply forecasting the obvious: The current economic expansion just entered its 10th year, which is twice the average length since 1945. We’re due for a recession.
This installment, on investing, will outline how various asset classes typically perform during a downturn, along with strategies for minimizing the pain and capitalizing on bargains. Sound investing is highly personalized and depends on age, life circumstances, risk tolerance and many other factors. So this guide does not constitute professional investing advice. But anticipating market reaction to a downturn can help investors figure out how to protect their assets based on their own personal needs. Younger investors with a long time horizon may choose to do nothing at all, while those closer to retirement age may want to make sure their principal doesn’t take a hit.
The first thing to know about the next recession is that it won’t be quite like the last one, which involved a huge housing bust and a terrifying financial crash. While some analysts think stocks are overvalued today, there are few signs now of the type of giant imbalances that toppled Lehman Brothers and other financial institutions in 2008. Safeguards put in place after the 2008 crash also put limits on excessive debt and other factors that can cause a crash.
There are still risks, however. Corporate debt is at record levels, and while default rates are low now, they could spike amid a confluence of adverse factors, such as rising interest rates, slowing consumer spending and tightening lending standards among banks. “The liquidity faucet gets turned off pretty quickly in a recession,” says finance professor Edward Altman of New York University’s Stern School of Business, an expert on corporate bankruptcy. “The default rate is going to go up, and go up a lot. It could get very ugly.” The most vulnerable industries are those with the lowest-quality debt, which include energy, retail and health care.
There may be bargains other than stocks as the next recession comes and goes. Home values have been rising steadily since 2012, and are now at new record highs, leaving many buyers priced out. But home values often fall during a recession—which could be just the break home buyers are looking for. “It may be an opportunity for a younger generation that has been completely unable to access the housing market,” says Peter Kenny. We’ll have more on that in a future installment of this series. Until then, protect your principal.
US banks are much healthier than they were leading up to the last recession, and they can weather a spate of defaults and a modest recession. European banks, however, have not fully recovered from the last meltdown, and remain vulnerable, especially with Britain leaving the European Union and other strains weakening the EU. Banks in China, now the world’s second-biggest economy, also have high levels of bad debt on their books, and that could matter more than it did a decade ago. “China was a non-factor before,” says Altman. “Now they’re a big factor.”