In this episode's "What's Up, Bro" segment, Motley Fool Answers co-hosts Robert Brokamp and Alison Southwick look to history for hints about one of the most common warnings lately on Wall Street: "We're overdue for a recession!" It's a prophecy that has been offered with increasing vigor for the past several years, during which the market has continued to set new highs and the post-Great Recession economic engine has kept humming along. So what are we to make of predictions both optimistic and gloomy and how should investors be thinking at this stage of the cycle?
A full transcript follows the video.
This video was recorded on Sept. 4, 2018.
Alison Southwick: So, Bro, what's up?
Robert Brokamp: Well, Alison, if you've ever spent any time watching CNBC, you've likely come across Art Cashin commenting on the markets from the floor of the New York Stock Exchange. Do you know who Art is? You'd recognize him if you saw him.
Southwick: I would. With a name like Art Cashin, there's no way he could be anything else but be a CNBC commentator.
Brokamp: Right. Have you ever heard of that? Like the studies your name does dictate somewhat what you'll do? Like people named Dennis are slightly more likely to become dentists. It's true. Yes, people named Lawrence are more likely to become lawyers, as in our case.
Southwick: We have one! We have a lawyer Lawrence.
Brokamp: It's true. Anyway, so Art's the director of floor operations for UBS and has been in the business since 1959, so he's been around a while. Earlier this summer he pointed out an interesting little bit of history. There's been a recession in every decade since 1850. Now the last recession we had in the U.S. was 2009, so we haven't had one, yet, this decade. The implication, of course, is that we're due for one. After all, there's only 16 months left until 2020. I found this all rather intriguing, so I thought I'd do a little bit of exploring to see where this historical factoid would take me.
First let's start with what a recession is. A lot of people think it is two consecutive quarters of declining GDP, and although that's definitely a sign of trouble, that's not how it's officially designated. A recession has occurred only when the folks at the National Bureau of Economic Research say so.
Southwick: Really! OK!
Brokamp: That's true. So the NBER is a private, non-profit research organization made up of 1,400 business and economics professors, and they're the folks who officially designate when recessions begin and when they end.
Here's the official definition of a recession from the NBER. It's "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough." That's the official designation.
Now you can actually go to the NBER website. It has all the data on all the recessions since 1857, so it's probably why Art Cashin began his little factoid with 1850. Since that period [the 160 or so years since then], the U.S. has experienced 33 recessions. On average a recession occurs every 4.9 years and lasts 17.5 months. And sure enough, Cashin is right. There's been at least one in every single decade since 1850.
Now, the opposite of a recession is an expansion, and the current one is indeed extraordinary. This summer it turned nine years old, making it the second-longest in history and just a year short of the all-time record. So, does this mean a recession is imminent?
Well, there's a saying among economists, and that is expansions don't die of old age. In other words, time alone isn't what causes an economy to contract, and a 2016 publication from the Federal Reserve in San Francisco seemed to confirm this. It found that unlike humans, whose chances of dying increase every year of living, is that true of an expansion? With every additional year of expansion, there's not an increase in chance of a recession in the following year.
Do you know when Australia's last recession was?
Southwick: Do I know, Bro? I do not.
Brokamp: It was 1991. So, if they can avoid a recession for almost three decades...
Southwick: Surely, we can.
Brokamp: Why can't we in the US? So, who knows? Maybe.
Southwick: They may be better looking and have lovely beaches. Delightful.
Brokamp: That is true. Probably better tans, as well.
Southwick: Delightful personalities. It's fun. I haven't met an Australian, yet, I didn't like.
Brokamp: That's true. Anyway, so we might be tempted to predict when the next recession will occur. A current Wall Street Journal survey of economists found a rough consensus that we're safe until 2020. These folks, in general, think we're going to make it through this decade, but 2020 looks rough.
Unfortunately, history shows that experts aren't so good at forecasting such things. There's a well-known study from the International Monetary Fund that found that economists failed to predict 148 of the 153 recessions from around the globe. So we'd love to be able to predict such things, but the history is we're just not very good at it.
Now, some might say that right now the economy is humming along just fine, especially given the recent announcement that the economy grew 4.2% in the second quarter, and that we had the current and very low unemployment rate of 3.9%. It certainly doesn't feel like things are slowing down. However, it's important to remember that NBER's definition of a recession includes that part about beginning "just after the economy reaches a peak of activity."
So good economic numbers are often the exuberance before the storm, especially if you're looking at something like a lagging indicator like unemployment. For example, a recent Bloomberg article cited an analysis that found that of the 10 recessions since 1950, the average time between the low point in unemployment and the start of a recession was just 3.8 months; so actually a very low unemployment rate doesn't mean that a recession is far off.
The bottom line of all this is that age alone doesn't mean a recession is imminent, but really good economic news doesn't necessarily mean a slowdown is far off. We just don't know when a recession will occur. The question might be, "So when it does happen, what will happen to your portfolio?" And for this I turned to an article by Doug Short at Advisor Perspectives who wrote about this a couple of years ago. Since then Doug has retired. But he looked at all the recessions since 1929 and he found that with every recession the stock market has declined except one time. What was really important was the valuation of the market before the recession started, and the times when the valuation was above average, the stock market dropped about 40%. When valuation was below average, the stock market dropped about 20%. There was the one time where the stock market actually made money.
So where are we now? According to Advisor Perspectives statistics, we're just a little short of the most overvalued market.
Southwick: I was going to say I think I know the answer.
Brokamp: Yes, exactly, and we've been talking about that for years. So with all this, history certainly suggests that a recession is coming sooner rather than later, and then when it does, the stock market could be cut 40%. Maybe 50%. But, as Warren Buffett once said [and by the way, when we're recording this it's on Warren Buffett's birthday, so happy 88th]...
Southwick: Happy birthday!
Brokamp: ... he once said, "If past history was all that is needed to play the game of money, the richest people would be librarians." So, really the question for you is ask whether you can ride out a 40-50% drop in your portfolio. If so, don't try to guess when the recession is going to come. It's going to happen eventually. We just don't know when. If that would change your plans [perhaps your retirement plans, your kids' college savings plan], it's perfectly fine at this point [we've had a good run], to put some of that money in cash and bonds; but for your longer-term money, as always, whatever happens to the economy we know that eventually the stock market recovers and reaches even higher values.