Rumblings in the news about trade tensions with China and instability in European markets have many investors wondering if a recession is around the corner.
About half of U.S. chief financial officers surveyed recently believe we’ll see a recession by the end of 2019.
Should we worry about a recession?
A Primer on Recessions
Both recessions and market downturns are unpredictable in the most literal sense of the word—they cannot be predicted. But history offers valuable insights into recessions.
Since 1926, there have been 14 recessions.
Defined by the National Bureau of Economic Research (NBER) as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators,” past recessions have lasted an average of 13 months.
Of those 14 recessions, eight were not associated with a bear market—defined as a 20% or more decline in stock prices. And of the 21 historical bear markets, nine have not been associated with a recession.
Suffice to say, one doesn’t guarantee the other.
Investing in a Recession
Investors may think they’d want to avoid being invested during a recession, but markets are forward looking. Historically, U.S. stocks have started declining eight months in advance of a decline in economic activity.
In fact, in 13 of the 14 recessions, the stock market bottomed months before the trough in economic activity. That is, stock prices began rising from their lows well in advance of the end of the recession. The average gain from the market’s lows to the trough in economic activity? About 30%.
Of course, peaks and troughs in economic activity are not known with certainty until many months after they’ve occurred. Since the NBER began announcing business cycle turning points, it has taken, on average, 15 months to announce the end of a recession.
By that time, U.S. stocks have risen, on average, 64%.
Manage Risk, Minimize Worry
Reacting to a recession, rather than a recession itself, is a true cause for worry.
Instead of trying to predict the next recession, sensible investors accept that market downturns—whatever their cause—can strike without warning.
The best preparation for investing in a recession is to construct a well-diversified portfolio that includes an appropriate amount of safe bonds.
That, and a healthy dose of discipline.
