Stocks and Recessions
People seem to be throwing around the big R-word everywhere you turn these days. According to many, the next recession is lurking right around the corner, and it is coming after your hard-earned portfolio. Recession is a scary word. The pain of the 2008 financial crisis is still fresh in our minds. To fear the next recession is to be human.
So what is a recession? It is important to understand that a recession is not defined by stock market activity. A recession is a regular and healthy stage of the business cycle. It occurs for a reason. Historically, expansions have always had a way of “overheating” which has led to inflation, high interest rates and a level of demand that the economy cannot sustain. A recession occurs as a means of hitting the reset button. One step back to take a few steps forward. Expand and contract, expand and contract.
Ok so where does the stock market come in? Yes, of course stock returns are related to the economy, but probably not as much as you might think. Time to look at some numbers.
The table below displays the performance of the S&P 500 before, during and after recent recessions. The primary takeaway might be a big surprise. We have experienced eleven recessions in the last seventy years. During those times, stocks have averaged POSITIVE returns.
The performance of an unmanaged index is not indicative of the performance of any particular investment. It is not possible to invest directly in any index. Past performance is no guarantee of future results. Rates of return will vary over time, particularly long term investments.
Positive. Up. The market can and has gone UP during recessions. Just one more piece of data that indicates that stocks have been relentless over time. Bear markets strike from time to time, but the level of fear of a recession is probably overblown.
No doubt, some of the headlines surrounding the trade war and inverted yield curve are a little bit scary. Don’t forget that we also have an accommodative Fed, rising GDP, low tax rates, a gridlocked government, reasonable equity valuations, low oil prices, low inflation, low interest rates and corporate earnings that continue to surprise on the upside.
What about that inverted yield curve? It is true – an inverted yield curve has historically preceded recessions. But did you know that the average lead time between the 2 and 10-year inversion and a recession is 14 months? Did you know the average stock market return in that time period is +22%? Not all yield curve inversions happen for the same reason, which was covered in Adam’s blog back in April. There is reason to believe that this one could be different.
One more thing, positive that is not to be overlooked… as Sir John Templeton once said, “Bull markets are born in pessimism, grown on skepticism, mature on optimism and die on euphoria.” If we had to guess where investor sentiment stands today it might be squarely in the “skepticism” range. Historically speaking, fear in the market is actually a good thing. This is what bull markets feel like.
If the R-word is making your nervous, we urge you to keep everything in perspective. A recession does not necessarily mean the market is going to crash. Even if it did, trying to predict the timing of a recession is like trying to predict the weather. Even the best usually get it wrong. Rather than make a hard stance about an unpredictable event that may or may not result in a short-term market loss, keep in mind the cost of trying to avoid a recession is probably higher than the cost of the recession itself.
Richard J. Martin and G. Adam Weingartner are registered representatives of LPL Financial. Securities and advisory services offered through LPL Financial., a broker/dealer (member SIPC) and registered investment advisor. Insurance offered through LPL Financial affiliates and other fine companies. CRN-2709847-083019