Last week a client told me that he believed a recession was imminent and he wanted to take investment actions capitalizing on that view.
At first blush, this seems to be a reasonable request. Many commentators foresee a recession as the result of the Federal Reserve’s aggressive interest rate tightening cycle.
However, this view reflects several beliefs about investing that are simply not true. One of the main suppositions is that the stock market acts in line with what is happening now. In fact, the stock market tends to take a collective view of the economy 6 to 12 months ahead and discount those future events.
In the case of this expected recession, if it’s visible now, stock market action should have discounted it last year.
Even more difficult is the idea that anyone can predict a recession ahead of time. To get an idea of how difficult it is to predict a recession consider this. Officially, recessions are designated by a group of nationally prominent economists at the National Bureau of Economic Research. One of the main indicators of a recession is two consecutive quarters of decline in Gross National Product. However, the economists look at many indicators of economic activity in determining when a recession began and when it ended.
But what’s most telling about this group of distinguished economists is that they determine the dates of a recession several years after the recession has ended and the subsequent recovery is well under way. In essence they struggle to call the recession afterwards and don’t even attempt to predict it ahead of time.
So what my client wants to do is something no economist would hazard and after he accomplishes this feat he then has to backtrack as much as a year to capitalize.
If you ask for the impossible, often you will be disappointed.
Instead, it makes more investment sense to take into account the regular occurrence of recessions and bear markets when you put together your investment portfolio. Being able to ride out these downturns without shifting positions has produced powerful long-term returns.
Over the last century, investors in the largest American companies (measured by the Dow Jones Industrial Average and the S&P 500) have doubled their returns on average every seven years. This doesn’t occur like clockwork but the longer you give it the closer you’ve gotten to these results.
When I began my investment career in 1982, the Dow hovered around 800 as it emerged from a two year double recession. Today, after a terrible period for the stock market, the Dow is almost 33,000.
That’s a great period for investors who shunned predictions and stuck with the market through thick and thin. Trying to save yourself some short-term pain is just as likely to sabotage your long-term performance as it is to help.
If there was a way to avoid the pain, I would be among the first to sign up. Instead, I do the next best thing. Put together a diversified portfolio that’s designed to prosper despite market swings and keep my investments intact as best I can.
No one knows whether this approach will work in the future but it makes more sense than trying to find a better crystal ball.
