With GDP back in the stall zone and the yield curve flattening, cues from the White House signal that it’s once again a race to see whether stimulus can stay one step ahead of the inevitable. Whether we have a year or five, there’s no better time to manage expectations and keep everyone’s eyes fixed on the long-term prize.
Nearly a decade after Bear Stearns crashed, the Fed remains excruciatingly cautious, wobbling in the same policy statement between signs of slowing growth and hopes for at best “moderate” expansion ahead. Wall Street digests the cues and markets pivot to more defensive postures.
It’s all business as usual in the long post-recession world, but for clients still nursing post-traumatic stress from 2008-9, even a brief flashback can shake years of hard-built confidence — leaving the advisor to once again pick up the pieces.
So start the conversation with what we know. The most nervous client you have is right. Yes, there’s a recession ahead. And yes, it will sting.
But the amount of time we have before the next downturn and the amount of pain it will cause are open for debate. A good advisor can lay out likely scenarios, weigh the portfolio impact and suggest countermeasures to balance the risks.
Let’s cut through the fear with a few hard facts.
2008 was a true black swan
I spent the weekend with a few old friends from Wall Street. Naturally the war stories came out. People who survived the 1987 crash, the long grind of the early ‘90s and the dot-com debacle had never seen anything like what the last full-fledged recession dished out.
It was bad, the kind of meltdown that history has only provided once every 70-80 years so far. The market took 17 months just to bottom and then needed until late 2013 to pay back every penny of shareholder pain.
With the Fed glued to the data, it would take a sudden and catastrophic collapse to repeat that disaster before massive intervention takes over.
At that point, if the collapse is that drastic and the intervention isn’t up to the challenge, “we’ll all have other things to worry about” besides equity performance, my friends say. In other words, a full-fledged repeat of 2008 — or worse — is unlikely except in an absolute doomsday scenario.
There’s a lot of ruin in an empire. The doomsday clock may be ticking a little louder for dynastic plans and future generations of retirees, but they’ve also got plenty of time to adjust their glide path.
But unprecedented things happen all the time, so go ahead and remind your nervous clients exactly what an exact repeat of 2008 could do to their financial position. Calculate the amount of cash it would take a simple buy-the-dip-and-hold strategy to erase the drawdown at various accelerated rates: in 3 years, 2 years, maybe even a year.
If that’s not good enough, you’re never going to get real comfort — the client will always be jumping at shadows, so suggest the best annuity program you can find and keep providing ancillary services to keep the AUM on board.
For everyone else, every recession in history has been not only survivable but ultimately a chance to create wealth in the long term. It’s about timing, stamina and statistics.
You know all of this already, but you’ll probably be the one sleeping a little better at night if you communicate it to your clients in a way that convinces them, especially in times like these when the recession buzz shifts from “whether” another downturn is on the horizon to how much time we have left.
Quantify the fear factors
The market itself is currently signaling that the economic status quo can persist at least another 2-3 years if nothing big changes across the macro landscape.
With corporate earnings as strong as they are, that status quo can translate into continued upside on asset prices, relief on stretched valuations or — depending on the numbers — some combination of the two scenarios.
The first outcome makes your clients richer before multiples finally reset. The second should calm fears that current market conditions are unsustainable. And in the meantime, every quarter of earnings growth kicks the cyclical ball down the road.
Since the inauguration, the two-year timeframe has shaped up as the biggest risk point in terms of where the Fed’s efforts to nudge short-term rates upward hits a wall. Beyond early 2019, the curve bakes in slower growth and even a slight chance that the Fed will need to hit the brake again.
Two years of relative calm isn’t awful. Going from historical data, a typical investor might reasonably expect to be around 20% richer when early 2019 rolls around.
Of course that’s an end-to-end number. Between here and there, the endless Wall Street rollercoaster could easily reach for higher highs and correct at least once, turning that anticipated 20% return at least briefly into a drawdown of at least 10% before the bulls take over again.
And it goes without saying that people who drop out of the market now lose their shot at padding their financial cushion before the economy shudders.
Even 20% in interim profit would effectively reduce the pain of a 2008-era 50% plunge by 10 percentage points two years from now. Stronger near-term performance or a slightly longer timeline should reduce the ultimate downside accordingly.
Likewise, buying the dip could turn the experience into a net win instead of a zero-sum game. Even 5% in cash at the right moment can turn into a huge bargain-hunting profit or simply meet liquidity needs while the current portfolio recovers.
Again, you know all of this, but when your clients get nervous, do you tell them?
Policy is a moving target
That 2019 timeline also assumes close to zero movement in Washington on any front.
Yes, some anticipation over tax cuts and a big infrastructure package is baked into the market right now. However, even if all that fizzles, asset prices aren’t at levels that trigger an instant collapse — a bona fide boom could keep stocks climbing another 1-3 years at least.
Tax cuts and spending are all it takes to feed the boom. The Treasury currently thinks we’ll be at 3% GDP growth by 2019, which is roughly what Wall Street has seen coming all along.
Compared to contemporary conditions, that’s a long way from a recession. That’s fuel for an extended rally.
Granted, policy could fail. External shocks could give the bears the recession trigger they crave. After all, the German banks keep predicting a coin flip: tails equal recession, heads preserve the status quo.
They’ve flipped “heads” year after year. Sooner or later, statistics go the other direction, unless of course the game is fixed.
But in that scenario, it’s all about the cushion.
Otherwise, the Fed sees maybe a 1 in 14 chance of a recession in the next year. The world’s economists might set the odds as high as double that level.
A year at those odds is a long time to sit on the sidelines. And you’re always watching the probabilities shift: maybe this time next year the sky will look a lot cloudier and it will be time to raise cash.
Or maybe it’ll be a utopia we haven’t seen in decades and even your annuity-craving clients will be calling to get back in the game.
It’s always a moving target. That’s why they have you. A robot can’t do it.