As I watched the stock market wrap-up show, the all-knowing prognosticators droned on about the odds of a recession. One quoted hedge fund manager Ray Dalio who had given a 25% prediction of a recession in the next year.Â
No one addressed the obvious math that this also meant there is a 75% chance there will not be a recession. They also forgot to mention that just a month ago Dalio gave a 40% chance of a recession. Has that much changed in the last month?
The talking heads rarely have anything meaningful to say. They are long on drama and short on fact. Their goal remains to fill air time and sell advertising. This does little to help the average investor.
Since the beginning of time, a free and capitalist economy ebbs and flows. When times are good, profits are high. New competitors see fat profit margins and come into the market place. In the process, they hire people and expand operations. This increases competition which typically leads to a lowering of profit margins. Weaker competitors struggle with thinner profit margins. Many that borrowed money have trouble servicing their debt. Soon, people are being laid off before hitting bottom. Then, the cycle repeats itself.
If the economy shrinks for two quarters in a row, it is considered a recession. There is no magic to it. This is simply what happens during a cycle of expansion, peak, contraction and trough.
However, to listen to today’s experts, a recession is the economic equivalent of the mythical Kraken rising from the sea to swallow entire communities.
Furthermore, the mind plays tricks on us. We reach back to our most recent history and portray that forward.
The last recession was The Great Recession. It lasted 18 months, during which time the stock market fell more than 50%. It was painful! However, it is not typical and not representative of what might happen during the next downturn.
Since World War II there have been eleven recessions. We average one recession about every seven years. We will have another recession. However, they don’t last forever.
During the average recession the economy shrinks about 1.5 percentage points while the stock market falls about 7%.
However, the averages can be quite deceptive. Interestingly, stocks have actually risen in four of the last nine recessions. Additionally, stocks produced positive returns six of the last nine times in the year prior to the start of a recession. This brings to question the belief that the stock market is always a leading economic indicator.
Although the market fell significantly between 2007 – 2009, during other recessions stocks have barely moved. As a point of reference, the stock market fell nearly 20% last December and dropped 10% last May. Neither of those events coincided with a recession.
Interestingly, we see many people confuse stock market performance with the economy. Although the two impact each other, they do not move in a lock-step manner. Unfortunately, in anticipation of a potential recession, many people abandon a logical long-term investment plan. This is a significant mistake.
As we have written about extensively, stock market investors need a long time-frame for success. Since World War II, one year after a recession, stocks are up more than 15%. Three years after a recession, stocks have increased 40% and five years later stocks have increased nearly 80%.
As we assess the current economic landscape, GDP growth is modest, but positive. Inflation is low and unemployment is very low. Although manufacturing is slowing, I wouldn’t leap to a recessionary conclusion.
Understanding this, famed fund manager Peter Lynch used to say, “If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.”
Given this, I can conclude that I simply don’t know what will happen—but I am not sure it matters.
Instead, I recognize that recessions happen. In fact, they happen with great regularity. We have survived every recession. You cannot stop a recession from happening.
Instead of worrying about the next economic data point, focus on the things within your control.
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- Live below your means.
- Save for a rainy day.
- Fund your retirement plan.
- Use debt sparingly.
- Pay down debt.
- Invest in good markets.
- Invest more in bad markets.
- Don’t take your financial advice from the TV or internet.