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Opinion: Everybody says a recession is coming, so is it or not?

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In August, the news media was blanketed with reports of the inverted bond yield curve, where short-term government bonds yield more than long-term bonds. Three out of five stories I heard on news outlets over a 12-hour span either stated or strongly implied that this is a reliable predictor of a looming recession.

Another report stated that an inverted yield curve “often” precedes an economic recession, which is true as far as it goes. But that statement ignores important information that should be explained along with it.

The fifth “expert” avoided the recession question entirely. They just said an inverted yield curve is unusual and could warp investor behavior and stock markets, which is also true, as illustrated by the Dow Jones Industrial Average dropping 800 points on the news of the inverted yield curve.

Let’s pause and review the definitions of a bond and an inverted yield curve.

A bond is simply a loan. Give the bond issuer money in exchange for the bond, and you receive interest payments during the time period of the bond/loan. Normally, the longer the bond, the higher the interest rate they pay you. That just makes sense, right?

The yield curve inverts when the universe of investors – professionals and amateurs – believes the U.S. economy will have trouble in the near future, which could cause the Federal Reserve to lower interest rates on newly issued government bonds in that imaginary future.

So investors buy up long-term bonds, and the law of supply and demand drives up prices, which drives down yields (the interest rate a bond pays as a proportion of the price of the bond). 

The key point is that this is all about investors predicting the future. 

Unfortunately, even so-called experts whose only job is to predict the economy, and the stock and bond markets, are terrible at it. A study by The CXO Advisory Group LLC called “Guru Grades” found a 47.3% success rate for these 68 media “experts” who made over 6,500 forecasts predicting market movements, up or down. That’s worse than a coin flip.

So, it’s not surprising an inverted yield curve is not a very reliable recession predictor. 

In the late 1980s, the yield curve inverted and then flipped back, before inverting again later, followed by a recession. The yield curve also inverted for a short time in the late ’90s and also in 2005-06, well before the next recession.

Even when a recession does happen, it can be several months or even two to three years later. 

So, yes, an inverted yield curve often does precede a recession – but not always – and even when it does, it may be too far in advance to be useful. Selling out of the markets too early and missing two or three years of potential market growth would be like creating your own personal recession. Knowing when to get back in is an equally impossible problem for market-timers. It’s literally not worth the expense and effort.

So, if you can’t time the stock market and you can’t time a recession, what can you do?

For starters, understand that nothing beats stock markets for long-term growth. You don’t need to be a stock-picker (just buy a large basket of stocks via exchange-traded funds or mutual funds), and you don’t need to get in and out for it to grow your money over the long run.

But do always assume the next recession could start at any time. Figure how much you’ll need to withdraw over the next three to five years – the length of the vast majority of the 28 significant market downturns since 1919. Keep at least enough out of the stock market, in bond funds for example (yes, ironic) to cover three to five years of withdrawals. So if markets tank and you need cash, you can sell some of your holdings from the nonstock side of your portfolio. If you can avoid selling stocks when they’re depressed, you don’t lose money.

This approach can help you sleep at night, and worry less, or not at all, about recessions. 

Sadly, reckless media buzz about imminent recessions could cause businesses to slow their investing and hiring, and hurt consumer confidence so shoppers buy less – the very things to potentially cause a recession.

In the end, the China-U.S. trade war, European economic uncertainty, tensions in the Middle East affecting fuel supplies and many other factors could explain a recession – if a recession happens. Record low unemployment, strong consumer confidence, solid earnings reports from U.S. companies and many other factors could explain continuing economic expansion and stock market growth – if that’s what happens.

The key is to plan for either case, and ignore the so-called experts who claim to have a crystal ball. They just don’t. 

Certified financial planner Kenny Gott is president at Piatchek & Associates and author of the book “Bottom Line Financial Planning.” He can be reached at kgott@pfinancial.com.

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