Since the beginning of 2022, all investors have heard about is that a recession is right around the corner. The culprit is usually the Federal Reserve and its interest rate hikes, as it has raised rates to quell economic activity to reduce inflation to a 2% target.
Unfortunately, there's nothing investors can do to control the situation. But what you can control are your own actions and how you respond to a recession if one occurs. Continue reading to learn how investors should handle recessions and if we should expect one soon.
We are nearing the end of a rate hiking cycle
Depending on who you ask, we've already experienced a recession. In Q1 and Q2 of 2022, the U.S. experienced two consecutive quarters of negative GDP growth. While this is often cited as a sign of a recession, it's not the official definition. Officially, there isn't a recession until the National Bureau of Economic Research (NBER) declares one, which it didn't do for the short period last year.
Since 1948, NBER has denoted 12 different recessions, meaning one occurs about once every six years. With that in mind, it's clear investors need to be ready for a recession, because one will eventually occur.
Recessions are tied to the business cycle and are typically highlighted by a drop in economic activity and a rise in unemployment. Furthermore, they often occur at the end of a rate hiking cycle.
Target Federal Funds Rate Upper Limit data by YCharts
As you can see in the graph above, the current rate range set by the reserve is near the levels seen during two of the last three recessions. But high rates don't necessarily mean a recession is here. Jay Powell and the rest of the Federal Reserve Board are attempting to engineer a "soft landing," in which they raise rates and eventually cut them without causing a recession.
This has seldom worked, but it could help the U.S. avoid a recession outright if done correctly.
Still, none of this is in investors' control; they just have to react to it. So what should investors do if a recession occurs?
The long-term trend of the market is up
As mentioned earlier, unemployment rises during a recession, and if you're one of those fortunate enough to keep their jobs, it's the perfect time to continue investing. Because there's economic uncertainty and earnings decline during recessions, the market often sells off due to short-term fears. But if you're a long-term investor (with at least a three-to-five-year time horizon), then the short-term worries don't have any merit.
Just look at this chart of U.S. recessions versus the S&P 500. While there are tiny dips during a recession, the long-term trend is up (the chart uses a logarithmic scale, so the effect of compounding growth doesn't drown out the small movements fifty-plus years ago).
While the world may have seemed like it was ending at some points during a given recession, five years later the market was almost always higher.
So if a recession occurs, your job is safe, and you have a well-established emergency fund for expenses, investors should look forward to the next recession, not fear it. With almost all stocks going on sale, it becomes a great time to purchase anything and everything. But if you want to take a more balanced approach, purchasing an S&P 500 index fund like the SPDR S&P 500 Index Fund (SPY 0.15%) is a great way to go, as it provides diversification across all market sectors.
A recession may be inevitable, but so is the recovery. As a result, investors need to understand that they play the long game in the stock market and keep a cool head on their shoulders when times get tough -- because they eventually will.
