Let's Say We're in Recession. Now What?

"We do believe we are currently in a recession," Lakshman Achuthan said yesterday on Bloomberg.

Yes -- right now.

Achuthan, an economist with ECRI, has been making the same call for about a year now. His forecasting models show that things like income growth, retail sales, and employment have dropped to the recessionary point of no return.

Now, a lot of people disagree. In December, Achuthan told Bloomberg: "If there's no recession in Q4 or the first half, then we're wrong." The first half ended several months ago, and he's still sticking with the call.

But let's give him the benefit of the doubt. Let's say we're currently in a recession. What's it mean for your investments?

I went back and looked. I created three hypothetical investors, all of whom have been investing diligently since 1900 (bless them).

The first has invested $1 per month, come rain or shine, into an S&P 500 (INDEX: ^GSPC  ) index fund (or the recreated version made by economist Robert Shiller). She's never missed a month since 1900.

The second also saves $1 per month, but she only puts it into the market when the economy is officially in a recession.

The third saves $1 a month but doesn't buy stocks when the economy is in recession.

How have these three done? Have a look:

Investor

Account Balance as of 2012

Invests every month

$205,951

Only buys stocks during recessions

$212,308

Stops buying stocks during recessions

$110,193

Sources: Robert Shiller; author's calculations. Numbers are adjusted for both dividends and inflation.

The differences aren't huge, particularly compounded over 112 years. But what matters is the trend. Those who invest continuously do pretty well. Those who only invest during recessions do better. Those who sit out recessions end up somewhere behind.

Here's something else to chew on. Take monthly S&P 500 data going back to 1871. Break it up into rolling 10-year periods (January 1900 to January 1910, February 1900 to February 1910, etc.). Now rank them in order of the highest returns. What do you get? Fourteen of the top 25 periods occurred when the economy was in recession. Do the same with five-year periods, and 16 of the top 25 best occurred when the economy was in recession.

For the whole period, the economy is in recession 24% of the time. So the odds of being at the beginning of a record-breaking market boom are more than double when the economy is in recession.

This should make perfect sense. When the economy goes into recession, people worry. When people worry, stocks fall. When stocks fall, they become cheap. When you buy cheap stocks, future returns will be high. This is really simple stuff -- and yet it trips up the vast majority of investors, professional or otherwise, causing them to underperform the market by buying high and panicking low.

We constantly hear -- and I'm guilty of this myself -- that a "risk" to stocks is that we'll enter another recession. But if your time horizon is more than a few years (and it should be), think about how backward that is. The best times to buy stocks over the last 100 years have nearly all come during recessions. That's when you set yourself up for big returns. That's exactly when you want to be investing.

It's the same story again and again. And yet recessions are one of the most feared events among investors. We're terrified of them! But why? If the biggest risk to markets is that we'll be handed an opportunity to earn higher future returns, then sign me up.

The S&P 500 bottomed out during the last recession in March 2009 at 666. With dividends, it's up 125% since then. I'm starting to hope Achuthan is right.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.


Read/Post Comments (15) | Recommend This Article (29)

Comments from our Foolish Readers

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  • Report this Comment On September 14, 2012, at 1:03 PM, Borbality wrote:

    As we've seen, "recessions" can vary in severity and length. If we are back in a textbook definition "recession" of GDP decline, it likely would not be of the unexpected, terrifying meltdown that accompanied 2008's recession.

    Earnings are still huge. There might be some "uncertainty" of policy or whatever, but it's nothing like "OMG the whole financial system could collapse."

    GPD has been inching along this year, and i think inching along in the other direction wouldn't be the most unexpected or devastating thing that could happen.

    Then again, sometimes it seems that the most obvious thing is the least likely.

    Of course, the point of this article is that you should stay invested, which I believe in. I've been selling a little bit of my less-desirable positions to free up some cash to put back into a Roth when next year rolls around, but I'm by no means going to panic at the first sign of things turning sour.

  • Report this Comment On September 14, 2012, at 2:31 PM, Darwood11 wrote:

    Well, if this is a recession, then thanks to the Fed the market is on a [short term] tear. More importantly, I don't know if stocks are currently cheap or not, as compared to future values. I don't know what they will be in 5 years. .

    Some say stocks currently are not cheap. I'll ignore that and continue to buy in steady increments, although I'd rather buy when stocks are falling than rising.

    BTW, I do wonder how many recessions have stock markets like the recent one, and how many had the likes of "helicopter Ben" at the helm? Not that it really matters.

  • Report this Comment On September 16, 2012, at 12:47 PM, HectorLemans wrote:

    I'd be careful about drawing too much of a conclusion from the investor who only invests during a recession. Since "official" recessions are almost always discovered after the fact (after several months of data are available to crunch), few if anyone would have the foresight to do that.

  • Report this Comment On September 17, 2012, at 10:53 AM, ejclason2 wrote:

    If I buy more stocks, at lower prices, during a resession, and keep my job, great. But if I lose my job, during a recession, and have to sell my stocks at even lower prices, not so great. It's this fear that makes it hard to buy stocks during a recession.

  • Report this Comment On September 17, 2012, at 8:48 PM, Tomohawk52 wrote:

    +1 for ejclason2 He brings up a good point for many average investors.

  • Report this Comment On September 18, 2012, at 2:02 PM, playtothebeat wrote:

    @ejclason: good point but i disagree to an extent - you should always have a 6+ month cushion in truly liquid (cash) assets. if that's not enough after you lose a job and you have to go into your investment portfolio, hopefully you don't take it out all at once.

    by the way, this is also why i think a Roth IRA is a great option (assuming you qualify) - you can withdraw your contributions tax/penalty-free at any time. it's like a savings account which grows (albeit one that also loses value if the market falls).

  • Report this Comment On September 18, 2012, at 6:47 PM, xetn wrote:

    Lets say the recession never ended. Why else would we have had QE1, QE2, Operation Twist, and now QE3?

  • Report this Comment On September 18, 2012, at 7:20 PM, 48ozhalfgallons wrote:

    Roth's are never tax free; only the gain is tax free after 59 1/2 years of age. Also, one is betting 1) His gains would be such that his tax bracket is higher in his retirement years than his earning years. 2) Congress won't change the rules before distributions are made. 3) Presumes longevity and insightful speculation.

    Someone who contributes to a traditional IRA is guaranteed to realize an immediate tax benefit, whereas someone who contributes to a Roth IRA is echoing Dirty Harry as in, "Who feels lucky?"

  • Report this Comment On September 19, 2012, at 12:01 AM, playtothebeat wrote:

    @48oz:

    you can withdraw your Roth IRA contributions (which are made on a post-tax basis) without paying penalties or taxes on those withdrawals.

    You're right with your points 1,2 and 3; although (2) can apply to any investment vehicle/instrument, be it a Roth, a Traditional IRA, individual trading accounts, etc. everything we do is to an extent dependent on our assumptions that the government does not change the existing rules. But that's not to say that the gov't won't pass laws which will tax our capital gains 50% or remove certain tax advantages of various retirement accounts.

    By the way, tax deductibility of traditional IRA contributions is limited if your AGI > 92k, and eliminated if it's above 183k.

  • Report this Comment On September 19, 2012, at 11:49 AM, Lucaskasan wrote:

    People who have been putting money in a traditional IRA have deferred taxes so long that they often forget that a traditional IRA is not tax-free. As a tax preparer I cannot tell you how many people are shocked at the tax bite when they take a distribution. In 2009, many of them were taking a 100% distribution. This means they paid deferred income tax on the contribution portion, tax on the gain portion and a 10% penalty on the whole amount because of early withdrawal. since the 60-day window had closed for most of them, they were stuck with the consequences.

    The whole point of deferring taxes is the assumption that you will be at a lower tax bracket when you take the distributions. In my experience this is true only for people who have had some sort of misfortune. If all goes well, the tax bracket does not change much at all. With a Roth, by the time you start taking distributions, you have already paid the tax on the contribution and that with cheaper older dollars. The gain is tax free, and after the first 5 years there is no early withdrawal penalty.

  • Report this Comment On September 20, 2012, at 11:06 AM, pondee619 wrote:

    Do the returns account for any income/apreciation of the alternative investments the last two investors used when not buying stocks? Did they buy bonds, real estate, gold or just hoard cash?

  • Report this Comment On September 20, 2012, at 11:17 AM, DMCSween wrote:

    I don't see it as possible to only buy during the dips...isn't this the same as trying to time the market? Therefore, the only choices are to (1) continuously invest and keep your money in the market; or, (2) try to time your purchases (bad idea!).

  • Report this Comment On September 20, 2012, at 12:24 PM, Gottamouthoff wrote:

    I am retired and investing in defensive stocks in one of two IRAs and would like to know if the rules are still to only have little in stocks. With the costs of most bonds and the payout so little is this a good idea yet. My Min. Distribution and SS makes only a small amount of my income taxable. and only if my wife withdraws from her annuities.

  • Report this Comment On September 21, 2012, at 3:04 PM, mclaugph wrote:

    If we're in a recession, why is the DJIA near all time highs? Just curious/confused by the disconnect. I'm skeptical the FED's policies are the only cause.

  • Report this Comment On October 01, 2012, at 6:26 AM, thidmark wrote:

    Sounds like one of those economists who have predicted nine of the last five recessions ...

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