Investor beware? Learn all about a down market with our recession survival guide.
Recessions are like earthquakes. While experiencing them, we always wonder if this is "the big one." Our thoughts go into self-preservation mode and only the bravest among us dare to see the opportunity.
Yet many of the best investment opportunities of the past century have come in the midst of economic recession. A study of past recessions reveals points to enter the market and acquire the best companies at prices that will materially affect long-term wealth. But how do we find these entry points now, without the benefit of hindsight? Where is the bottom?
Are we in a recession now?
An economic recession is generally defined as two consecutive quarters of negative gross domestic product growth. Recessions are very difficult to gauge because we don't know if a quarter has been negative until after the fact. We don't know for a fact that a recession has taken hold until at least six months after the fact, when two full quarters of negative GDP have been officially recorded. Certainty only comes with hindsight.
However, there is a very good chance we're in a recession right now. Not everyone agrees, but about 45% of economists believe we are in the midst of a recession. Among the believers are some of the greatest market experts, namely Warren Buffett and the brain trust at Goldman Sachs
How long will it last?
Every recession is unique. How do we know how long this one will last? And, how will we know when it has hit bottom? Well, the average duration is about 11 months. Assuming this is an average recession that started in December or January, it would end near the end of 2008. However, 11 months is only an average, and many past recessions have been longer or shorter.
The important thing to note about the market's behavior is that the stock market anticipates and reacts before the economy. Typically, the stock market begins to decline before the recession starts and experiences its steepest fall during the first stage of a recession. The market then begins to recover near the bottom of the recession. This is the important stage to watch for. The best time to invest has been when the market is recovering and the economy is still going south.
Where's the bottom?
Recessions have typically hit bottom roughly halfway through; then the market usually turns around. On average, the market has begun to recover a little past the halfway point, about the sixth or seventh month for an average, 11-month recession. So, if we can just figure out how long the recession will be, we can start investing a little after the halfway point and be in great shape. Right?
Well, it's not that easy. How do we know if we're seeing the bottom? This is dicey, because we only know for sure that the economy has hit bottom after it starts to recover, when backward-looking economic gauges turn positive. And after the economy has begun to recover, it's not the bottom anymore and we've missed it. This is a pain in the tweasle.
How can we tell the market is at the bottom? It's the same thing. One only knows for sure that the market has hit bottom after it begins to move up. How can we tell that the market is truly moving higher and not just posting a short-lived market rally? Technically speaking, it's when the market makes a series of higher lows and higher highs and changes its technical pattern. But, after the market has established a pattern of steadily advancing, we've already missed the bottom.
When to scoop up the bargains
Judging from past recessions, there seems to be a nirvana stage when the market begins to advance and the economy is still in the dumps. This seems to be the ideal entry point. But an important thing to remember is that you don't need to thread the needle and find the absolute bottom. First of all, you'll never find it unless you're a lucky guesser. Second, it doesn't really matter, as long as you have a long-term investment mindset.
No one ever knows which way the next 10% move in the market will go, and timing the market has proved to be impossible time and time again. What we do know is that every market eventually rises up out of a recession, and if at some point during the downturn you buy some of the very best companies at low valuations -- General Electric
We like to bet on the long-term prosperity of the market rather than short-term gains from market timing. But being able to estimate when the market and economy is bottoming out can lead you to the cheapest gateway to great stocks.
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Fool contributor Tom Hutchinson holds no financial position in any companies mentioned. He'd like to, but ever since the last round of bad economic numbers, he became frightened and locked himself in his basement. Now he just does push-ups and sings show tunes all day. The Motley Fool has a disclosure policy.