Rising interest rates, a more assertive Federal Reserve, challenges in addressing inflation, and geopolitical issues have all posed risks to the U.S. equity market, potentially impacting how users invest stocks in the U.S.
For a significant part of the year, the market seemed resilient, with stocks rallying despite these concerns. However, recent trends suggest a shift, with the stock market expiring symptoms of that during a recession.
The S&P 500 Index declined by 2.5% in just the past week, marking a 10% drop from its July high. Similarly, the Nasdaq fell 2.6% last week, now 12% down from July. (as of end of October, 2023)
With both indices experiencing a correction, it's important to understand what is a stock market recession? And how can investors navigate through it?
Before we dive deeper into the subject, I invite you to check my latest book, The Art of Investing. There, you can find many valuable insights to improve your investing performance.
Stock Markets During Recessions
A market correction happens when there's a decrease in the price of stocks, either in the overall market or a specific sector. Even investing in Amazon or Tesla stocks during the most recent recessions led to a serious drop in investment value. Specifically, it's when prices drop by 10% to 20% from their most recent high.
This can happen to broad markets like the S&P 500, specific types of goods like commodities, or even single stocks from popular companies. This can be a significant concern for investing in stocks in the short term.
These drops often occur because of sudden economic changes or big events that make investors rethink their decisions. Since 1974, there have been 24 of these corrections. Notably, five of them, in 1980, 1987, 2000, 2007, and 2020, went even deeper, turning into bear markets where prices fell by more than 20%.
So, essentially, the market tends to see a correction every couple of years, with a bigger drop about once a decade, potentially throwing a wrench in popular investing stock strategies.
What to Do During a Stock Market Recession?
Bull markets, characterized by rising stock prices, don’t last forever. They inevitably give way to bear markets or market corrections, which, though unnerving, are natural market rhythms every investor will encounter.
To navigate these periods, context is key. Historically, since 1966, even the harshest market correction has spanned only about 15 months, which is a brief spell compared to the longevity of bull markets.
These corrections can be swift and unpredictable, as evidenced by the 2020 pandemic-induced bear market which lasted just 33 days. Contrast this with prolonged bull markets, like the one from 1986 to 2001 which spanned 4,494 days, or from 2009 to 2020 which neared 4,000 days.
Statistically, bull markets average over 2,000 days, while severe corrections hover around 446 days. What's more, the rewards of staying invested during growth periods are substantial: an average gain of 209.2%.
Meanwhile, a typical correction might only reduce a portfolio’s value by 40%. So even if stock market returns after recession are negative, over the longer term the average investor is better off staying in the market.
Continuing to invest, even amidst uncertainty, often proves more beneficial in the long run, and is a great stock investing tip for beginners.
Steps to Take During a Market Correction
Navigating market downturns can be challenging. While booming markets often involve risk-taking, corrections serve as reminders to re-evaluate asset allocations, helping investing long term in stocks.
1. Assess Risk Tolerance
Gauge both your emotional and financial resilience to potential losses. Using an investing stocks calculator to gauge potential losses can be helpful.
2. Seek Guidance
Taking surveys from financial institutions like Vanguard or Charles Schwab can pinpoint your investor profile, helping match you with a suitable asset allocation.
Over time, the market can tilt your portfolio's balance. Regularly readjust by selling overweight positions and buying into underweight ones.
4. Factor in Life Stage
Younger investors with long-term goals can typically withstand market dips. In contrast, those nearing or in retirement should lean towards a more conservative risk profile, emphasizing regular rebalancing and diversification.
5. Post-Retirement Precautions
Recent retirees, especially in the withdrawal phase, should note that early poor returns can strain portfolios. In downturns, consider curtailing withdrawals or delaying large expenditures to avoid selling assets at lower values.
Every investor's journey is unique, but being proactive during market corrections can safeguard and optimize one's financial future.
Diversifying to Prepare for a Stock Market Recession
Diversification is often hailed as a bedrock principle, especially when investing long term in stocks. Having a portfolio that spans a variety of asset classes, such as stocks, bonds, and cash, is akin to not putting all your eggs in one basket.
This diverse spread ensures that as some assets might wane, others could wax, creating a balance.
How you apportion each asset should be a reflection of your personal investment goals, your willingness to shoulder risks, and the time you have before you need to tap into these funds.
But as the market ebbs and flows, even a meticulously crafted portfolio can veer off course.
This is where diversification of investment enters the fray. Diversification is essentially a periodic health check for your investments. You might find yourself selling some of the assets that have gone beyond their intended share and buying those that have dwindled.
For instance, diversification examples include allocating assets in a certain mix: for instance 50% in Apple Stock, 20% in Tesla, and 15% each in AMD and Intel stocks, and eventually buying or selling based on the movements in prices.
Learn more about diversification in my related post:
Now, let's talk strategy during those bear market phases. They might be challenging, but they're not devoid of opportunities. Enter tax-loss harvesting. By strategically selling off assets that have lost value, you can offset your capital gains, offering a silver lining in the form of a reduced tax bill.
But a word of caution here: the wash-sale rule dictates a brief moratorium on buying a similar asset right after a sale, so tread carefully to avoid missing out on potential rebounds.
Speaking of safety during tumultuous market phases, there's merit in considering risk-averse assets. T-Bills, or Treasury bills, are akin to short-term IOUs from the U.S. government, while Certificates of Deposit (CDs) are a bank's promise to pay back your money with interest after a set period.
Notably, the latter stands firm even when interest rates play hopscotch, offering a reassuring stability. Another step to consider for a diversification of portfolio is for those who have already balanced their portfolio is dollar-cost averaging.
It's the discipline of regularly investing a predetermined sum, come rain or shine. While it doesn’t promise the highs of timing the market right, it offers a shield against its caprices, especially given the unpredictability of bear markets and their deceptive rallies.
Learn more about Dollar-Cost Averaging in my other article:
Stock market recessions might be daunting, but with the right strategies and a sprinkle of discipline, they can be navigated with finesse, turning potential roadblocks into avenues for growth.
Bottom Line on Surviving During a Stock Market Recession
Understanding and adeptly maneuvering through market corrections is pivotal. While the unpredictability of bear markets can test an investor's mettle, a strategic blend of diversification, rebalancing, and savvy tactics like tax-loss harvesting can turn the tide.
Opting for risk-averse assets offers a cushion, and the disciplined approach of dollar-cost averaging serves as a steady compass. Remember, investing is a marathon, not a sprint. Embracing a long-term perspective, coupled with informed decisions, can transform challenges into opportunities.
As the tapestry of market cycles unfolds, equipped with the right strategies, investors can not only weather the storms but also thrive in them.
I hope this was useful for you!