Ever find yourself wondering why adults often seem glued to news about the stock market, especially during tough economic times?
Well, imagine the stock market as a giant mood ring for the economy. When things are going well, it shines bright with optimism. But when a recession hits, that ring can turn stormy and unpredictable.
For example, the chart below illustrates consumer sentiment since 1980. Consumer sentiment refers to the overall attitude of individuals toward the economy and their personal financial situation.
Notice how consumer sentiment declined drastically in 2008 and 2020 when recessions hit the United States.
This chart reports three measures of consumer sentiment from the University of Michigan Surveys of Consumer Sentiment. The index of current economic conditions (ICC) is constructed from questions regarding individual's financial well being relative to a year ago and individuals perception timing of large purchases for their home such as an appliance. The index of current economic conditions (ICE) is derived from expectations for individual's financial situation in one year, expectations for the country as a whole in one year, and expectations for volatility in the next five years. The index of consumer sentiment is derived from all of the components of the ICC and the ICE.
That's what we're diving into today: the whirlwind world of the stock market during a recession.
You see, a recession is not just a word that economists throw around; it's a period when the economy slows down, and things like jobs and money become a bit harder for everyone to hold onto.
During these times, the stock market becomes a roller coaster of highs and lows, making it a fascinating, if somewhat nerve-wracking, spectacle to observe.
But why does this happen? And what does it mean for you and your retirement?
That's exactly what we're going to explore. We'll break down the complex dance between recessions and stock market behavior into bite-sized, easy-to-understand pieces. Think of it as decoding a secret language of money and markets, where every twist and turn tells us something about the health of the economy.
Armed with this knowledge, you'll not only be able to follow along at the next cocktail party, but you'll also understand the signs and signals of economic change yourself.
So, buckle up!
We're about to embark on a journey through the ups and downs of the stock market during a recession, and by the end, you'll be more informed about this important aspect of our economy.
How Does a Recession Affect Retirees?
In the world of economics, a recession takes center stage, casting its shadow on financial landscapes. Defined as a big decline in economic activity, a recession marks a period of reduced production and higher unemployment. It's like a storm that sweeps through, leaving few sectors untouched.
As the economic winds shift, the impact on financial markets can be seismic. Picture the stock market as a sailboat navigating unpredictable seas. There are many reasons why a recession takes place, and understanding the source of a recession has been a focus point for economists.
One example is the Great Recession that followed the housing bubble of 2007. The housing market was surging with high prices, speculative investments, and a spike in subprime mortgage lending.
As the bubble expanded, the inevitable burst sent shockwaves through the economy. This triggered the 2008 Great Recession.
This recent history is a stark reminder that economic euphoria can quickly transform into a sobering downturn. The housing market crash serves as an example of how connected markets can amplify a recession, leaving lasting scars on economies and households alike.
However, the bright side is that recessions tend to be relatively short-lived compared to periods of economic growth.
For example, consider the graph below.
This chart shows the S&P 500 price index with the start of bull and bear markets adjusted to zero. The returns for each period show the relative price returns from the start of the bear or bull market to the end of the market cycle. Bear markets are defined as declines from the prior highest market level that extend beyond -20%. Subsequent bull markets begin from each bear market bottom. Date Range: January 3, 1956 to present Source: Clearnomics, Standard & Poor's
You can see that bear markets – measured by 20% dips in the stock market – typically occur once a decade and usually only last for a year or two.
On the other hand, bull markets (periods of extended growth) tend to last for years at a time. In fact, Americans enjoyed around a decade of uninterrupted stock market growth during the 2010s–until the Covid-19 pandemic reversed the market briefly.
Now, let's zoom in on a group that’s extra sensitive to these downturns: retirees.
For those who have bid farewell to the daily grind, the safety of their financial nest egg becomes paramount. Understanding stock market behavior can help retirees who rely on their investments to fund their lifestyle in retirement.
The ebb and flow of the market can impact retirement savings, pension funds, and investment portfolios. As such, retirees should take control of their finances to weather the storms of a recession and ensure a smooth journey throughout retirement.
How the Stock Market Reacts During a Recession
Here's how the stock market may react during challenging economic times:
Price Plunge: One of the most immediate and noticeable reactions is the nosedive of stock prices. Investors, gripped by fear and uncertainty, engage in a frenzied sell-off, causing a sharp decline in stock prices.
Volatility Takes Center Stage: If the stock market were a rollercoaster, a recession would be the loop-de-loop. Volatility becomes the name of the game, with daily price swings resembling heart-stopping twists and turns.
Sector-Specific Impact: Not all sectors are created equal, and a recession highlights differences. Defensive sectors (like utilities and healthcare), may weather the storm better than cyclical sectors (like manufacturing and finance).
Flight to Safety: Investors, like migratory birds seeking warmer climates, often flock to "safe-haven" assets during a recession. While not guaranteed, government bonds and other low-risk investments such as cash and money markets have historically become the go-to choices to preserve capital.
While these trends are common during recessions, the stock market is complex. Many factors can influence its behavior. Investors, therefore, often find themselves navigating uncertain waters.
Common Challenges Faced by Retirees in a Recession
Retirees can face many challenges during a recession. Their financial well-being is often tied to the performance of financial markets. Here are some common challenges, along with examples to illustrate the impact:
Portfolio Value Decline:
Challenge: Retirees can have a large portion of their savings invested in the stock market. During a recession, the market experiences a downturn, leading to a decline in the value of investment portfolios.
Example: Imagine a retiree who had diligently saved for years, only to see the value of their retirement portfolio drop due to a market downturn. This can jeopardize their planned income and lifestyle.
Reduced Income from Investments:
Challenge: Retirees often rely on investment income, such as dividends and interest. During a recession, companies may cut dividends, and interest rates may decrease.
Example: A retiree counting on steady dividends from their stocks may find their income stream reduced if companies slash dividends to conserve cash in a downturn.
Impact on Pension Funds:
Challenge: Some retirees receive pension income, which can be affected by the financial health of the companies or entities providing the pensions. Economic downturns can strain pension funds.
Example: A retiree relying on a pension from a struggling company may face the risk of pension cuts.
Healthcare Costs and Inflation:
Challenge: Healthcare expenses tend to increase with age, and retirees may face rising medical costs during a recession.
Example: Consider a retiree on a fixed income trying to cover healthcare expenses. If medical costs rise or inflation outpaces their income growth, maintaining the same standard of living becomes challenging.
Impact on Real Estate Values:
Challenge: Many retirees own real estate as an investment or as their primary residence. A recession can lead to a decline in property values, affecting the overall net worth of retirees.
Example: A retiree planning to sell their home to fund their retirement may face difficulties if the housing market leads to a lower-than-expected sale price.
Navigating these challenges requires careful financial planning. Retirees may find it beneficial to work with financial advisors to develop strategies that help reduce the impact of recessions on their financial well-being.
Strategies for Retirees to Navigate a Recession
In the tumultuous waters of a recession, navigating the stock market by focusing on what you can control may help protect your money when you need it most. Here are a couple of strategies that can serve as a foundation in these challenging times:
1. Diversification and Asset Allocation:
One fundamental pillar of weathering a recession is a well-diversified portfolio. Try to avoid putting all your financial eggs in one basket. Diversify across different asset classes, such as stocks, bonds, and cash equivalents. While stocks are volatile, government bonds can act as a more stable anchor. Strategic asset allocation, based on risk tolerance and financial goals, can also help create a resilient portfolio.
Many investors think they are diversified when they are not. We’ve seen this first hand at Covenant Wealth Advisors.
2. Regular Portfolio Checkups and Rebalancing:
The market is a dynamic force. That’s why it’s good to conduct regular checkups on your investment portfolios. Assess whether the asset allocation (your mix of stocks, bonds, cash, etc…) still aligns with your long-term goals and risk tolerance.
Rebalancing can help during a recession, as market movements can skew the original allocation.
This chart shows the current composition of a stock and bond portfolio that was created in 2009, but never rebalanced. Stocks and bonds are represented by the S&P 500 and Bloomberg Aggregate Bond Index, respectively. The white dotted lines show the starting allocation. Source: Clearnomics, LSEG
Selling some assets that have performed well and reallocating funds to underperforming or more stable investments can help maintain a balanced portfolio.
3. Secure Income Streams:
Retirees should explore income-generating investments, such as dividend-paying stocks and bonds. Dividends can provide a steady cash flow, even when other capital gains are elusive. Also, consider investments less prone to market volatility, like high-quality bonds. This can ensure a consistent stream of income during market uncertainties.
Pro tip: Consider avoiding an over concentration of your portfolio in only dividend paying stocks. Too much exposure to dividend stocks can create additional problems.
4. Emergency Fund and Cash Reserves:
In times of economic uncertainty, having a financial lifeboat is essential. Maintaining an emergency fund with enough cash to cover several months' worth of living expenses is a wise move. This fund acts as a safety net, allowing you to avoid selling investments during market downturns.
5. Long-Term Perspective and Behavioral Discipline:
Investing is a marathon, not a sprint. Try to maintain a long-term perspective and resist the urge to make impulsive decisions based on short-term market moves. Emotional discipline is key during market downturns; panic selling or making drastic changes to the investment strategy can have lasting consequences.
For example, this chart tracks the performance of four portfolio allocations: 100% stocks, a 60%/40% stock bond split, 40%/60% stock bond split, and a 100% bonds. The chart is reindexed to the beginning of 2008 to show performance relative to the Great Recession. The dotted vertical lines show the annotated performance events. The 100% stock portfolio is represented by the S&P 500, while the other three use iShares U.S. Bond indices before expenses and fees.
Staying focused on long-term financial goals and trusting your retirement plan can help you weather the storms of a recession with greater resilience.
These strategies, in alignment with individual financial circumstances, may empower you to navigate the stock market in a recession and steer your financial ship toward calmer waters.
What Happens to the Stock Market in a Recession?
In this article, we've uncovered strategies for navigating a recession. From diversification and regular portfolio checkups to securing reliable income and maintaining cash reserves, you now have a toolkit to navigate the financial storms.
As the economy evolves, staying informed is a retiree's compass. Keep abreast of market trends, reassess portfolios regularly, and make adjustments when necessary. Planning ahead is the name of the game. Engage with financial advisors, stay attuned to the pulse of the economy, and be ready to adjust sails in response to changing winds.
Navigating a recession during retirement is like sailing uncharted waters. It requires a mix of financial wisdom, resilience, and a steady hand. While economic downturns are inevitable, they should not dictate the course of your golden years. With the right strategies, a long-term perspective, and adaptability, retirees can weather the storms.
In the grand scheme of retirement, recessions are temporary. Armed with knowledge and good planning, retirees possess the tools to not only survive but thrive amidst the financial ebbs and flows.
We hope that you’ve found this article valuable when it comes to learning about ‘What happens to the stock market in a recession?’
Be sure to request a free retirement assessment to help ensure that your personal investment plan is structured to help navigate the next recession.
Disclosures:
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond, Reston, and Williamsburg, VA. Registration of an investment advisor does not imply a certain level of skill or training. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place. Hypothetical examples are fictitious and are only used to illustrate a specific point of view. Diversification does not guarantee against risk of loss. While this guide attempts to be as comprehensive as possible but no article can cover all aspects of retirement planning. Be sure to consult an advisor for comprehensive advice.