The “R” Word

There has been a fair amount of talk about a possible recession coming to us in the near future. I want to discuss what that means and also give a bit of historical context so that we understand the recession when a recession actually shows up.

A recession is a macroeconomic term that refers to a significant decline in general economic activity in a designated region. It is typically defined as two consecutive quarters of economic decline, as reflected by GDP in conjunction with monthly indicators such as a rise in unemployment.

First of all, we investors should not have an excessive fear of recessions. They are a normal component of the business cycle and are unavoidable. In fact, roughly every 4 years since the Great Depression of 1929 and every 5 years since WWII, a recession has occurred in the U.S. The longest period of calm in the economic cycle was during the decade of the 90s when the U.S. economy did not experience a recession at all.

Economies need recessions to take a breather. Financial writer Ben Carlson likens recessions to drivers in a NASCAR race. He writes, “drivers make somewhere between 5-8 pit stops over the course of the 200 laps in the 500-mile race. NASCAR drivers can’t push their cars to the extreme for the duration of the race without taking a break. They need to stop and fill up their gas tanks, change their tires and make other adjustments.” This is an apt analogy as economic growth cannot continue uninterrupted forever either.

While recessions are painful in the short term, they also provide investors with lower prices to buy stocks with any cash they have on the sidelines. In my opinion, when recessions create a downward stock market, they wash out all of the short-term speculators in the market. This is a positive in the long run because by the end of a recession, all that is left are the long-term investors who have kept their eye on the investment ball. Those are the investors that will reap the benefits of a new base for the recovery of the market post-recession.

There are two other benefits besides buying stock in a recession that benefit the long-term investor. First, in 4 of the last 9 recessions, stocks actually rose. Likewise, in the year leading up to a recession, stocks were positive 6 out of 9 times, which dispels the myth that the stock market always acts as a leading indicator of economic activity.

The second is those post-recession market returns. Now, the average return percent during a recession is -1.5% since 1954, but the returns one year after a recession are 15.3%. After 3 years, 40.1%, and 5 years later, 78.7%.

Aiming to benefit financially from the correct timing of the end or even the beginning of a recession can be a true fool’s errand, however. Remember the Great Recession that began in December of 2007? The economists at the National Bureau of Economic Research, who are basically the official scorekeepers of recessions, didn’t discover the recession until December 2008 – a year late, and only a few months before the episode ended.

The previous recession began in March 2001 – but the NBER didn’t call it a recession until November 26 of that year! By amazing coincidence, that was actually the month it ended (as they told us many months later).

We may not get our recession this year, but we can count on one coming home to roost at some point. Remember that you have an investment plan, and it is executed by us every day, recession, or no recession.