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 (^GSPC +1.46%) 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:

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.