Recession? So What?
What is a Recession?
Generally accepted definitions:
Recession (n) - two straight quarters of negative real GDP growth.
Correction (n) – a sustained decline in equity markets of over 10% and less than 20%. Note: A “bear market” is a >20% pullback in the market.
People often confuse an economic recession with an equity market correction. While the two are related, they are different events. It is important to remember the following when thinking about these financial events:
The stock market reflects what investors think today about what will happen tomorrow. So, a correction (or bear market) is typically an indication that investors think the business environment and earnings are going to get worse.
On the other hand, a “recession” is a measurement of what has happened in the last few quarters with the economic output as measured by the Gross Domestic Product.
One tends to look forward. The other tends to look backward.
Looking Backward
The National Bureau of Economic Research (NBER) is one of the most cited resources for research on Gross Domestic Product and, hence, recessions. NBER identifies 11 recessions since 1950.
Yet, when you look at the S&P 500 since 1950, there have also been 39 official corrections (defined as periods of greater than 10% declines) over that same period. Clearly, we can have corrections without recessions. In fact, corrections have occurred three times as often as recessions.
Market Corrections Since 1950
Correction length listed in calendar days. Red represents corrections lasting longer than a year, yellow between 157 and 288 days, and green 104 or fewer days. Data Source: Yardeni Research. Table by Motley Fool.
Looking at Today
The Atlanta Federal Reserve publishes GDP results and puts an estimate together for where we are currently. On July 1, with the end of the second quarter, their GDPNow tracker is indicating that Q2 will be negative real GDP growth of -2.1%. Final numbers will not be issued until the end of September with estimates along the way. Since Q1 was negative real growth of -1.6%, we may technically be in a recession (remember, a recession is defined as two straight quarters of negative real GDP growth) but not know it officially until September!
When the final numbers are published, and assuming they are as negative as forecasted, the headlines will ring out – “We are in a recession!” There will be a lot of debate about the definition of a recession, when it officially begins, how credible the numbers are, etc.
For us as investors, however, it is more important to ask, “So what? If we are in a recession, what do we do?”
Looking Forward
On April 1, 2022, Forbes published an article entitled “How Stocks Perform Before, During, and After Recessions May Surprise You”. This article by a Senior Contributor from Darrow Wealth Management dives into the performance of stocks (using the S&P 500 Index) around all eleven of the major recessions since 1953. What was the percentage change 6 months and 12 months before a recession, during the recession window, and then 6, 12, and 24 months after? Here is their big “surprise.”
While we are always cautious about forecasting the future based on the past, there has been a historical trend of markets declining before recessions, staying relatively flat during recession periods, and rising after the recession ends. And the longer you stay invested the higher the probability of regaining what might have been lost going into a recession.
Below is the chart and summary analysis from Darrow Wealth Management that supports their article.
Are you surprised? Probably not. It makes sense. But here is the problem and why you shouldn’t make too many investment decisions based on “recession” information - the government doesn’t report final GDP numbers in a timely manner. They can’t. They must roll up numbers from companies and other economic filings and reports, and it takes 3 months to get final results. While they will issue estimates along the way, we could be technically in a recession as of June 30th (yet won’t officially know it until September 30th) and out of a recession almost 3 months before it is official! Confused? To push a baseball analogy, making an investment decision based on recession announcements is like swinging at a pitch after the ball has passed home plate and the umpire has already made the call!
What Does This Mean for Investors?
The questions remain:
Do today’s market and today’s valuations accurately reflect the future? No one knows for sure.
How long will we be in a recession? The average since 1950 has been 10.3 months. And 48% of the time, the market was positive during a recession with only a -1% average return.
How long before the market will recover? Again, no one knows, but more than 80% of the time, markets delivered positive returns to investors within 6 months.
What do I do with recession data? It is really hard to time the market. And, using GDP and recession data is not that helpful as it is too backward-looking and delayed.
In conclusion, the market has clearly taken a beating this year as we are in “bear territory.” There may be more declines ahead if the anticipated recession runs deeper or longer than expected. However, history shows that recessions do end, and markets do recover. And the recovery is something investors shouldn’t miss by trying to time the market or by reacting to recessionary news.
As always, it is important to have an investment strategy that contemplates these downturns, an asset allocation that reflects your appropriate risk and timeline, and a disciplined (statistical) approach that allows you to press on with your strategy even when things don’t “feel” good.
Here is a chart from Dimensional Fund Advisors. They take an even longer look at how the market has performed across over a century of recessions. Most of us won’t be investors for over 100 years, but it does help you to keep things in perspective.
Market Performance Over a Century of Recessions
Click for the interactive version. Shaded periods indicate recessions. Source: Dimensional Fund Advisors
Sources:
https://awealthofcommonsense.com/2020/03/the-relationship-between-recessions-and-market-crashes/
https://www.fool.com/investing/2022/03/20/how-long-do-stock-market-corrections-last/
https://www.atlantafed.org/cqer/research/gdpnow
https://www.dimensional.com/us-en/insights/market-returns-through-a-century-of-recessions
