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Charting the Odds of a U.S. Recession: Will Investors Be Ready?

The U.S. will likely face recession in the next five years. How should investors prepare?



The U.S. economic expansion is now in its ninth year, and the economy will likely cross the divide into recession sometime in the coming three to five years. As the chart shows, since 1946 there has been just one 10-year period and only four five-year periods in which the U.S. did not experience a recession, and the current expansion is already the third-longest in postwar history.

While we don’t expect a recession in the next six to 12 months, recessions are notoriously difficult to forecast, so it’s worth speculating on the events and environments that could trigger the next one.

We see one scenario where the economy bumps along until a major external shock hits: think another Korean War, a messy euro breakup or an oil supply shock. The recession – caused by the resulting plunge in asset prices and falling business and consumer confidence – could be relatively shallow but last longer than usual due to insufficient fiscal and monetary responses.

Or consider a second scenario, where an internal buildup of imbalances and overheating goods, labor or asset markets rattle the economy and compel the Fed to hike rates. The script for this endogenous recession would likely be sharper and deeper, but having built up enough “dry powder” in the form of higher rates, the Fed could cut rates to promote a V-shaped recovery.

The real-deal next recession could, of course, turn out differently – and given the uncertainty, how should investors prepare? In our recent Secular Outlook, we discuss a focus on valuations (lots of good news is priced in to markets) and capital preservation, seeking relative value in rates and credit, and looking to a global opportunity set, including emerging markets. Nontraditional options like managed futures have also shown strong historical performance during bear markets and may mitigate risk in broader portfolios.

Bottom line? Enjoy this expansion while it lasts. But don’t wait until the next recession hits to start preparing.

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The Author

Joachim Fels

Global Economic Advisor

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For more charts critical to understanding markets, economics and policy, visit our Smart Charts digital library.

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Momentum, trend-following, managed futures - are terms that can seem intimidating and opaque for many investors. But, while these types of investment strategies may be less familiar than traditional strategies, they can be quite intuitive and offer attractive diversification and return potential that is worth getting to know.

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Disclosures

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Managed futures strategies involve entering into financial derivatives that seek to follow price trends. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

 

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