As the central banks continue to raise rates in their fight to curb inflation, many observers have pointed to the current outlook for the economy and financial markets as uncertain: Did the central banks wait too long to control inflation? Is a full-blown recession imminent?
Uncertainties tend to raise fears, which can be a driving factor of short-term market behaviour. It is therefore not surprising that the markets have been extremely volatile. Today, fear appears to be the dominant emotion governing prices in equity markets. Just as excess exuberance can cause prices to overshoot their underlying values during bullish times, pessimism can drive price declines during more bearish times.
It may be difficult to put a positive spin on today’s situation. Over the summer, there were promising signs that inflation was slowing here at home. However, inflation remains persistent, supporting the continuing bearish sentiment that aggressive rate hikes, arguably needed to curb high inflation, will further slow economies, put downside risk on equity markets and avert a soft landing. It’s no wonder that many of us feel as though we are already in recession— the current narrative, alongside increasing household expenditures, a higher cost of borrowing and stock market declines, certainly hasn’t helped to support optimism.
Whether or not we avoid a recession remains to be seen, but it’s worthwhile to remember that downturns are a normal part of the economic cycle. Moreover, the stock market and the economy don’t always move the same way at the same time, and predicting how the markets react to recessions is difficult, if not impossible. A recent study looked back at recessions in the U.S. since 1945, suggesting that the S&P 500 Index actually rose an average of one percent across all recessionary periods. And, in almost every recession, the markets began their climb well before its end.
Uncertainties will always be with us and some of the most successful long-term investors are adept at separating their emotions from investment decisions. This is not easy to do, but there are techniques and products available that can help. Systematic investing can limit the urge to otherwise succumb to market timing. Some look to managed products to put buy-sell decisions on the regular watch of others. We also manage risks to help cope with the unavoidable volatility. Diversification continues to be a proven way to increase stability and lower risk by spreading assets across different securities, sectors and asset classes, among others. Those who consider high quality investments will also worry less about enduring values during uncertain times, secure in the knowledge that any price setbacks should be temporary.
This period of economic uncertainty is expected to continue. Yet, economies and modern capital markets have always adjusted and progressed over time. This time is no different. The investing journey is a long one, filled with both ups and downs, and there may be merit in never underestimating our ability to continue moving forward, despite the uncertainties.