Prepare your finances for a recession despite strong GDP report, warn financial advisors: ‘Plan for more disruption’

Finance
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The U.S. economy grew in the third quarter, reversing a negative trend from the first half of the year — but weakness looms under the surface and households shouldn’t be lulled into a false sense of financial security, economists and financial advisors said.

“I think investors should still continue to be cautious … and plan for more disruption,” said Winnie Sun, co-founder and managing director of Sun Group Wealth Partners, based in Irvine, California, and a member of CNBC’s Advisor Council.

Gross domestic product — a sum of all the goods and services produced in the U.S. — grew by 0.6% from July through September, the Bureau of Economic Analysis estimated Thursday. That figure amounts to 2.6% growth on an annualized basis.

“For the U.S. economy, a developed economy, that’s very respectable, slightly above average,” said John Leer, chief economist at Morning Consult, a data research company.

Why it may be ‘a chilly winter’

That GDP expansion marks a rebound from a deceleration in both Q1 and Q2. Two consecutive quarters of negative growth meets the common definition of a recession — though the National Bureau of Economic Research, generally considered the arbiter of downturns, hasn’t officially declared one.

Nonetheless, many economists don’t expect the recent growth to persist.

The headline growth in Q3 was driven by non-domestic factors, like an increase in exports overseas, Leer said. But the U.S. can’t depend on strong global demand to continue, due partly to a strong dollar, which makes U.S. products more costly to buy, as well as economic challenges in Europe, an ongoing slowdown in China, and high food and energy prices globally, Leer added.

I think investors should still continue to be cautious … and plan for more disruption.
Winnie Sun
co-founder and managing director of Sun Group Wealth Partners

He also pointed to a slowdown in residential and non-residential fixed investment, which includes things like homebuilding and construction of commercial buildings and warehouses.

And consumer spending, which accounts for two-thirds of the U.S. economy, “slowed to its weakest pace since the first quarter when spending first hit a wall in response to soaring inflation,” Diane Swonk, chief economist at KPMG, wrote in a tweet.

“Bottom Line: This may be the strongest and only positive print on GDP growth we see for a while,” Swonk wrote. “Bundle up for what looks to be a chilly winter.”

And there are concerns beyond some underlying weakness in the federal data, economists said.

Consumer prices this year have risen at about the fastest pace in four decades, pressuring household finances. The Federal Reserve has also been raising borrowing costs aggressively to reduce inflation. Higher interest rates have already pushed mortgage demand to the lowest level since 1997.  

“Export growth will soon fade and domestic demand is getting crushed under the weight of higher interest rates,” Paul Ashworth, chief U.S. economist at Capital Economics, said in a research note. “We expect the economy to enter a mild recession in the first half of next year.”

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What consumers can do to prepare for a recession

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What this boils down to: Don’t be lulled into a false sense of security, financial advisors cautioned.

While a downturn isn’t inevitable, households can take financial steps to prepare in case one comes and triggers layoffs and more market volatility along the way.

“Think of a reasonable worst-case scenario — how would you fund it?” said Allan Roth, a certified financial planner and certified public accountant based in Colorado Springs, Colorado.

1. Shore up your cash reserves

Households should always ensure they have access to cash in case things go wrong, whether job loss, home repairs or unexpected medical bills, for example. But with recession might come greater likelihood of needing to draw from that financial buffer.

The general rule of thumb is to have three to six months’ worth of expenses handy. Sun advises clients to have six months, plus an extra three months for each child in a household.

Consumers should consider adjusting their emergency-fund needs based on overall stability, Roth said. For example, someone working at a start-up company generally has a less dependable job income stream than a tenured university professor and may therefore need more cash access, he said.

“Cash” also has a broader definition than parking money in a traditional bank account with paltry returns, advisors said. Consumers can look to high-yield online savings accounts or money market funds, for example, advisors said, which currently pay a higher return.

2. Reduce your debt burden

Paying down credit-card debt and other high-interest loans — and making sure households aren’t racking up more — is also of primary importance, experts said.

Something that lends further urgency to this advice: Variable rates are likely to increase more due to the Federal Reserve’s anticipated interest-rate hikes.

“There’s a potential for some folks to lose their jobs, and you’d hate to see in two or three months people don’t have any savings, have gone into debt, and it triggers a wave of personal bankruptcies or other forms of financial hardship,” Leer said.

Clients are showing more financial anxiety these days than they have in many years — but paradoxically, many households spend more to feel better, and that may be happening on credit cards, said Sun. Credit-card balances jumped 13% in Q2 — the largest year-over-year increase in more than 20 years, according to a recent report from the Federal Reserve Bank of New York.

Sun advises focusing on paying down debt with interest near or above the inflation rate, which is currently about 8% on an annual basis. The only potential deviation would be to first save money in a 401(k) plan up to the company match, if that’s available, she added.

Households might also try to reduce their debt burden by downsizing to one car instead of two to cut monthly auto payments, for example, Sun said.

Borrowers with a fixed-rate home or other loan at 3.5% are in a good position and don’t necessarily need to accelerate their debt payments, Leer said.

3. Stay the course on investments

Investors should also stick to their investment strategy — and not panic in the face of big stock and bond losses, Roth said.

Pulling money out and ditching a well-laid investment plan locks in losses, which right now exist only on paper. The S&P 500 stock index is down 20% in 2022; meanwhile, U.S. bonds, typically a ballast when stocks tank, are down about 16% in the past year.

“We’re like heat seeking missiles,” Roth said. “We buy high and sell low.”

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