The truths about investing in stocks during recessions

LATELY, the dreaded “R” word has been making its rounds. Yes, I’m talking about a recession, a risk that is not confined to any specific country. In fact, in early July, the chief of the International Monetary Fund, Kristalina Georgieva, warned that a global recession cannot be ruled out.

The thing is, recessions are not within our control. Yet, as investors, we are affected by it. This begs the question, what should stock market investors do now that the possibility of a recession looms in the background?

I don’t have a panacea, but what I can offer are historical perspectives – truths, if you will – about stocks and recessions. The US stock market is a great case study. According to the Visual Capitalist, the US accounts for nearly a quarter of global economic output while its stocks make up around 40 per cent of the total global stock market capitalisation, based on data from the Securities Industry and Financial Markets Association.

Stocks in past recessions

A common refrain I’ve heard over the years is that stock prices are bound to fall during a recession. But the data says otherwise.

Ben Carlson is the director of institutional asset management at Ritholtz Wealth Management. His research, as reflected in his recent blog post titled “Timing a Recession vs. Timing the Stock Market”, there have been 12 recessions in the US since World War II. The average return for the S&P 500 – a broad barometer for US stocks – when all these recessions took place was 1.4 per cent, a positive number.

Of course, there were some horrible returns within the average. For example, the recession that stretched from December 2007 to June 2009 saw the S&P 500 fall by 35.5 per cent. But there were also some decent returns. For the recession between July 1981 and November 1982, the S&P 500 gained 14.7 per cent.

Hence, it’s not a given that stocks will definitely fall during a recession.

Staying invested

If you are thinking of selling your stocks during a recession, you may want to think again.

Carlson’s research showed that If you had invested in the S&P 500 six months prior to all 12 recessions since World War II, and held on for 10 years after each of them, you would have earned a positive return on every occasion. Furthermore, the returns were largely rewarding.

The worst return was a total gain of 9.4 per cent for the recession that lasted from March 2001 to November 2001. The best was the first post-World War II recession that happened from November 1948 to October 1949, a staggering return of 555.7 per cent.

After taking away the best and worst returns, the average was 257.2 per cent. Not too shabby!

In short, holding onto stocks in the lead up to, through, and in the years after a recession, has historically produced good returns most of the time.

The cost of avoiding stocks

Some of you reading this may also wonder: What if I tried to sidestep a recession? What if I had perfect knowledge of when a recession would start and end, and I simply sold stocks at the start of a recession and bought back in at the end? The answer is – you would do poorly.

Michael Batnick, the director of research at Ritholtz Wealth Management, has the facts to prove it. In his October 2019 blog post titled “12 Charts You Ought to See Before the Next Recession, Batnick showed that a dollar invested in US stocks at the start of 1980 would be worth north of US$78 around the end of 2018 if you had simply held the stocks and did nothing.

But if you invested the same dollar in US stocks at the start of 1980 and expertly side-stepped the ensuing recessions to perfection, you would have less than US$32 at the same endpoint.

Said another way, avoiding recessions flawlessly would have caused your return to drop by more than half.

Which bottomed first - stocks or the economy?

When an economy teeters on the edge of a recession, a popular belief is to sell your stocks before the bottom falls off. The idea is tempting, but it is also flawed. Here’s what the data shows: Stocks tend to bottom before the economy does.

Let’s go back to the three most recent recessions in the USA prior to 2020’s pandemic. These would be the recessions that lasted from July 1990 to March 1991; from March 2001 to November 2001; and from December 2007 to June 2009.

During the first recession in this sample, data from Yale economist Robert Shiller showed that the S&P 500 bottomed in October 1990.

In the second episode, the S&P 500 found its low 15 months after the end of the recession, in February 2003. This phenomenon was caused by the aftermath of the dotcom bubble’s bursting.

For the third recession, the S&P 500 reached a trough in March 2009, 3 before the recession ended.

In summation, even if you are right today that the economy would be in worse shape in the months ahead, stocks may already have bottomed or be near a bottom. Only time will tell.

Did companies grow in past recessions?

A recession is a time when an economy is in decline. When the economy is in poor health, it’s easy to think that all businesses are either suffering or are at best stagnating. But this isn’t always true for all companies. Some businesses can thrive.

The recession that lasted from December 2007 to June 2009 was one of the worst in the US’s modern history. The country’s real gross domestic product fell by 4.3 per cent from a peak in the fourth quarter of 2007 to a bottom in the second quarter of 2009. Unemployment also spiked from 5 per cent in December 2007 to 10 per cent in October 2009 .

But while the US economy was in trouble, the revenue of software-as-a-service pioneer Salesforce grew by 51 per cent in FY2008 (fiscal year ending January 2008), 44 per cent in FY2009, 21% in FY2010, and 27 per cent in FY2011 . Salesforce was not the only one.

iPhone manufacturer Apple saw its revenue rise by 27 per cent in FY2007 (fiscal year ending September 2007), 53 per cent in FY2008, 14 per cent in FY2009, and 52 per cent in FY2010. Booking Holdings, the owner of Booking.com and Agoda.com, enjoyed revenue growth of 26 per cent in 2007, 34 per cent in 2008, 24 per cent in 2009, and 32 per cent in 2010 .

Hence, investors in these three US-based companies had nothing to worry about even during one of the worst recessions for the country in modern history. Their businesses kept growing at an admirable clip, which meant that their underlying economic values were increasing rapidly too.

Parting words

When we’re on the brink of a recession, it may feel like tomorrow will never get better.

But brighter days eventually do come. As one of my favourite finance writers, Morgan Housel, once wrote: “Every 5 to 7 years, people forget that recessions occur every 5 to 7 years. ” Recessions are normal or par for the course.

Now we circle back to the question posed at the beginning of this column: What should stock market investors do now that the possibility of a recession loom? You have history’s responses. The next step is up to you.

The writer is the co-founder and portfolio manager of Compounder Fund (https://compounderfund.com), a long-term-focused global equities investment fund, at Galilee Investment Management Pte Ltd. He has a vested interest in Apple and Salesforce. Holdings are subject to change at any time.