Other than forecasting market returns for the year ahead, few financial topics have been more popular in January than predicting the next recession.
The U.S. economy is already facing the realities of a trade war with China, rising interest rates, record levels of corporate debt, and slowing earnings growth. On top of that, market volatility reached extreme levels last month. Of the 19 trading days in December, the Dow moved at least 400 points 10 times. When volatility peaks, investor sentiment becomes more pessimistic, and it’s human nature to wonder about the next bad thing likely to hit the stock market.
To be clear, it’s a matter of when, not if, a recession occurs. So, rather than focus on timing, the better question for investors is: “How will it affect my portfolio when the next recession arrives?”
In economic terms, the Great Recession lasted 18 months and brought six consecutive quarters of shrinking GDP. The S&P 500 fell 37 percent during the recession and 57 percent peak-to-trough. It’s generally accepted as the worst economic crisis in this country since the 1930s. That’s the most recent example, but an obvious outlier.
Since World War II, the U.S. has experienced 10 other recessions. Those lasted an average of 10 months and none saw GDP or stock prices sink as much as what we experienced a decade ago. The S&P 500 was actually positive in six of those 10 recessions.
The 2001 recession is interesting because it followed a 10-year period of economic growth, second only in length to the current expansion. That recession lasted only 8 months despite being exaggerated by a bursting of the dot-com bubble and the Sept. 11 terrorist attacks.
History tells us that long periods of economic expansion (like the one we are still experiencing) are rarely followed by deep recessions. Further, even though recessions will probably coincide with market declines, the data underscore how difficult it can be to predict specific timing.
Since World War II, the S&P 500 was negative only three times in the 12 months leading up to a recession. In the 12 months after those recessions, the S&P averaged returns of 15.3 percent.
The recent decline in stock prices is at least partly affected by recession concerns, meaning some of the negativity is already priced in. Although the Great Recession is the most recent example, the next recession is unlikely to hurt nearly as much.