Some claim that a global recession has begun following a lot of the recent economic data. Others might argue that major problems only exist overseas, and signs of any recession is not present in the United States.
Regardless of who is right, we expect a recession won't be confirmed until twelve months or longer after the fact. This is similar to what we've seen in the past and is usually confirmed by the National Bureau of Economic Research (NBER) as well as other sources. The challenge is that predicting a recession is harder than you think.
A lot of this debate and investor concern has been fueled by the recent steep decline in interest rates and does deserve further attention. Many of you may be wondering what happens if we experience zero or negative interest rates in the future? To be blunt, nobody knows with certainty what will happen because we've never experienced such an environment in the United States. It's also expected many "experts" will pretend they know what will happen and we recommend investors use caution around those who provide this kind of advice. Just remember, interest rates can increase too which many seem to forget.
As many of you know, our firm uses facts, logic, and an evidence-based approach to financial planning and investing. Instead of trying to forecast or "guess" future events, we look to focus on what we know to be true as well as seek to provide our clients with a higher probability of success. In our recent blog A Stock Market Cycle and Investor Discipline, we highlighted interest rate yields and inflation expectations are at generational lows. Given this current environment, we address several investor questions below that relate to the possibility of zero (or negative) interest rates including considerations for the next recession:
If we anticipate a recession is coming, should we get out of the stock market and go to cash and bonds? No. If you have a good financial plan in place that is properly managing investment risk and liquidity, then you should have been planning for market volatility (or you would have been 100% in the stock market). Also, some bond strategies may carry more risk than you think even though they are deemed to be safe.
Aren't my treasury bills (T-bills) safe in a recession or low-rate environment? Yes, the principal value for individual issues is guaranteed, however, T-bills are not immune to inflation. There are other solutions to accomplish this.
Should we continue to expect low inflation? By traditional measurements, inflation is at generational lows in the United States. However, if you look closer it is present in the economic data and in the goods and services we buy every day. Should tariffs continue, this is expected to also push up inflation pressures.
Should I sell all my fixed income if rates go to zero? Probably not all, but yes, it's possible some of the longer duration or higher risk bond funds may no longer offer appropriate compensation for risk. Fixed income has had a historic bull market given declining rates. At these levels it seems reasonable to expect most fixed income will produce lower returns going forward and some of these strategies may also bear greater risk if rates reverse course and increase. Hence, some holdings may warrant selling and rebalancing into higher quality, short-term duration funds which should still provide ample liquidity, but be less sensitive to interest rate fluctuations. In terms of individual bonds, their yield to maturity or yield to worst should not be impacted.
Given the risk of recession and interest rate fluctuations, will this hurt my real estate investments? Not necessarily as it depends on what sector of real estate (public vs. private; residential vs. commercial, etc.). Also, if short-term interest rates began to rise, it doesn't mean this will be bad for the sector.
Are there any fixed income strategies to consider that are not tied to interest rate fluctuations? Yes, some exist such as alternative lending, private debt, and inflation protection strategies. However, it is important to evaluate if these are appropriate in the context of one's risk tolerance and asset allocation.
Should I still hold as much cash if rates keep dropping? Any good financial plan will always retain a healthy amount of cash for emergency reserves, essential living expenses, and other needs. This level of liquidity avoids having to sell or realize losses in a down market or tough recessionary environment.
Given recession risks, should I reallocate into alternative investments? While some alternatives may offer diversification benefits for certain investors, many of these solutions will still feel the pain and impact of weak economic activity and recessionary periods. In particular, many private alternatives don't price each day or will experience a lag in reporting. Lack of liquidity is often an issue too for many private alternatives during a period of distress.
Should I own individual bonds or bond mutual funds? Potentially both, especially if rates continue to fall further.
How long should we expect low interest rates? There is a lot of research that suggests the best predictor of future rates are today's interest rates. So, it's possible low rates may continue for some time.
What is the impact of a long-term, low rate environment? Its positive for those looking to borrow, refinance, structure businesses, debt, and many other common financial needs. For income investors, it may present a challenge to generate enough income due to lower yields. It also seems reasonable to expect that traditional fixed income returns will be lower in the future compared to the past twenty or thirty years. This will impact financial planning and retirement income expectations for some. A low-rate world may also decrease future stock market returns which was a critical discussion that we covered earlier this year in The 60/40 Investment Debate.
For investors who have a sound financial plan in place and are properly managing risk, most of this discussion should have no impact on you. However, a second opinion never hurts.
As always, we appreciate our relationship with you, and we are here to help.