Fiducient Advisors strives to help clients achieve attractive returns, while mitigating risk. Important tenets of our approach include constructing thoughtfully created investment menus for defined contribution plans and broadly diversified portfolios for pension funds. In all instances, we discourage market timing. Given extreme uncertainty in both the markets and the economy, the need for diversification and patience may be as important as ever. 

Investors ponder the risk of recession and how that might impact their portfolios. The debate among experts repeatedly focuses on whether we will experience a hard landing (recession) or a soft-landing (“Goldilocks” environment where inflation is tamed and recession avoided). This is the two-sided risk pundits argue and while these are legitimate concerns, we contend there is a third, less anticipated risk that should be on your radar. Below we present all three risks, debunk several myths, and share practical investment considerations.    
  
Risk #1: Recession is likely, I’m nervous.  If you are in this camp, it is helpful to recall that recessions are an ordinary part of the economic cycle. Since 1950, the U.S has experienced a recession roughly every 6.5 years, with the average recession lasting about 10.5 months.¹   

So how might your portfolio be impacted by a recession? On average, markets peak seven months prior to an economic downturn and bottom out three months before economic growth resumes.²  This means attempting to time the market can be a fool’s errand. Moreover, history has shown time is on the side of patient investors as broad markets have recovered to pre-recession levels following each and every pullback. For a diversified investor, the benefit becomes apparent when considering recovery times. 

In advising long-term investors, we underscore the value of thoughtful diversification as well as the challenges of market timing by pointing out the best days for equities have actually occurred during bear markets or recessions. In fact, the 10 best days of percentage gains for the S&P 500 Index all took place during recessions.³ 

Risk #2: Soft-landing, we are good to go! If indeed the Fed can tame inflation without forcing the economy into a recession, and we resume solid economic growth, this can translate to good news for a variety of asset classes. Even though diversification is often considered a risk mitigation tool, it can play a role in capturing upside potential. Investors placing all their investment eggs in one basket may miss the rally. 

Lower interest rates would make the “safe play” (cash) more penal for investors. Equities, particularly small cap stocks, and high-yield bonds could fare well. And long duration opportunities (think growth stocks, venture capital, private equity, etc.) may experience tailwinds too. 

Risk #3: No recession, anemic growth. This less-contemplated environment creates a sideways setting where we never quite experience a recession but, because the economy avoids its “medicine”, we fail to achieve attractive growth levels for some time. Equity returns can be muted in this backdrop. However, fixed income may be relatively attractive and marketable alternatives (think hedge funds) could potentially shine. 

Hedge funds - a challenged strategy for the better part of the “free-money, stocks soar” decade - could add value. But a middling economic growth scenario can present opportunities beyond hedge funds. Large companies with solid balance sheets but slow growth may be inclined to acquire faster growing small cap companies. And private equity shops with special situations expertise may shine.   
 
Where does this leave us? 
Whether we experience a recession or not, it is healthy to acknowledge that recessions are a regular part of our markets and economy. Because all three of the risks presented remain a possibility, investors would be wise to construct broad, thoughtfully diversified portfolios with the likelihood of at least some portion of their allocation performing well in any situation. This offers the prudent investor a fighting chance of achieving long-term goals, and that’s about as much as we can strive for in this challenging environment. 

For additional details and to discuss how these risks may impact your portfolio, please reach out to any of the professionals at Fiducient Advisors.