Recession: Lessons from the past

With the pundits wondering if we are about to enter a recession, the best place to look is backward, not forward.

Recession: The very word strikes fear into our hearts, especially with television newscasts constantly broadcasting bad news about the state of our economy. And yet, we all know the truth. There is nothing more normal – and some would say healthy – than for an economy to go through a recession.

Recession number 22

If the National Bureau of Economic Research (NBER) officially declares that the United States is in a recession, it will be the tenth one since the 1950s… and the twenty-second in just over a century. To confirm a recession, the NBER goes by a number of indexes, including economic growth, employment, real income and sales. If these indicators are down for two or more quarters in a row, the economy is in a recession. In other words: economic activity declines; the country produces less wealth than before.

Not necessarily here in Canada

We have to realize that a recession in the United States does not necessarily mean a recession in Canada. For example, Canada did not have recessions in 1970, 1974 or 2001. On the other hand, the ones in 1981 and 1991 were particularly hard on us. Economists do find, however, that recessions tend to occur in several countries at the same time. Even if Canada can avoid the next major recession, it may nonetheless be affected by recessions or economic slowdowns in other countries.

So far, the first casualty has been our investment portfolio.

Recessions and stock market returns

In recent months, the stock markets have experienced two significant slumps: one in August and the other in November. Since then, things have been extremely volatile. It’s not uncommon for indexes to jump up or down 200 points on any given day. That’s because the markets don’t like recessions: they imply less growth and lower profits for corporations. This volatility suggests that the markets are “discounting” a recession, i.e. the recession is already being reflected in stock prices.

That said, it would be wrong to confuse a bear market (a long falling stock market) and a recession. For example, since 1950, only five out of nine recessions have coincided with the appearance of the famous bears. Conversely, the markets don’t always need a recession to spark a crisis!

When the markets rebound

Another thing to keep in mind: even when stock prices take a spectacular tumble, the market tends to recover fairly quickly. Let’s look at the table below. It shows that during the past six recessions, the S&P 500 posted positive returns in the six months following the recession. And here’s an even more encouraging fact that’s not included in this simplified table: in the ten years following a recession, the S&P 500 grows by an average of more than 140%.

Source: Standard & Poor’s

What do we do now?

Still, at the moment we’re in the midst of the storm. Should we adjust our portfolios? That depends on each individual situation – and in particular, on your personal investment horizon. If your horizon is several years, probably all that’s needed is a minor rebalancing. If it’s a short-term horizon, a more thorough analysis of the situation could be in order. As well, you’ve got to know that the managers of many investment funds have themselves rebalanced their portfolios – so it’s important not to go rebalancing something that has already been looked after.

Keep in mind, too, that certain types of investments often perform quite well in a recession. These include stocks that have recently undergone a loss. But shares of public utilities such as gas and electric companies, of alcohol and tobacco companies, and of pharmaceutical corporations may also perform quite well.

For discussion

All these questions could be up for discussion the next time we meet. Meanwhile, please remember that all recessions have their positive aspects: they often produce a correction in terms of risk assessment in the economy. With a bit of luck, by the time the pundits declare that we are officially in a recession… we’ll already be on our way out the other side.

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