Recessions - What you should know

There it is again, the oh so infamous 'R-word.' Whether it's media headlines or market pundits, everyone is talking about when the next recession will hit. This is no surprise given that in 2019 markets marched on higher and higher after breaking the record for the longest bull run in the history of the stock market late in 2018. With the 2008 financial crisis still in the rear-view mirror, everyone wants to know when the next crisis will occur.  Don't believe my word for it, data from google shows 2019 was also record-breaking year for the number of recession related google searches.[1]

Today I wanted to highlight some key information investors should know as it relates to recessions.

What is a recession?

Recession is a broad term. There are many different types of recessions. Some affect specific geographic regions, and others can even affect specific industries (think manufacturing).  Simply put a recession is when an economy stops growing and starts shrinking. Generally, when we're hearing about the 'next recession' the commentators are typically referring to a recession of an entire country (like the United States), or even a global recession. The technical definition used by economists is two consecutive quarters of negative GDP growth.

What happens during a recession?

During a recession you see rising unemployment which usually leads to a drop in consumer spending.  This drop in consumer spending has a trickle-down effect that can send ripples throughout the economy and is often accompanied by declining incomes and corporate profits, reduced capital investment, which all leads to even more unemployment, this can develop into a negative spiral if left unchecked. Most of the time governments and central banks need to get involved to help prop up the economy.

Central banks use what is called monetary policy. Their primary tool is interest rates. During a recession central banks will lower rates, encouraging investment and borrowing in an effort to try and kick start the economy. The government uses slightly different tools which fall under what is called fiscal policy. The more common actions include things like tax cuts and increased government spending. The hope is that these actions will help to stabilize the economy and stimulate spending during times of underperformance.

How often do recessions happen and how long do they last?

Market corrections are not the same as an economic recession, and although they are correlated there is nothing saying that they HAVE to happen at the exact same time.  While market corrections (a 10% drop in asset values) happen every couple years or so, there is less regularity on how often recessions occur.  1980 saw a recession which was followed by a second recession only one year later.

Then there are recessions that are much further apart like the one that ended in May of 1991, followed by the bursting of the dot com bubble a decade later, which led to a recession in March of 2001. According to data from The National Bureau of Economic Research, since World War II the American economy has experienced 11 business cycles with the average recession lasting around 11 months. To put this into perspective, the most recent recession during the 2008 financial crisis lasted approximately 18 months.[2]

What do recessions mean for stock investors?

If you're an investor in stocks, recessions likely mean you see the businesses you own drop in value, a result of investors fears over declining corporate profits. If you're a long-term investor, this should be nothing to fear as the best investments are almost always made during the worst times. Markets have a tendency to overreact both in good times and in bad. During recessions the markets have historically reacted in a way that makes things seem a lot worse than they truly are.

This means that during recessions, you'll likely find some of THE BEST buying opportunities with amazing bargains on some of the best companies in the world. If you're an investor with a short time horizon who relies on your investments for income, failing to plan for recessions can be extremely problematic. In 2008, failing to plan resulted in many having to postpone their retirement, and in the worst cases many retirees had to go back to work. Proper planning helps to mitigate these risks by allocating money needed for income into investments that are unrelated to the stock market and the economy. You should not be invested only in stocks if you're planning to need large portions of your portfolio over the next year or two.

Can I time the recessions?

Maybe but it's highly unlikely. The question is never will a recession occur (they will occur), the question is always when? To my knowledge there are no investors who have been able to time the market on a consistent basis. There are obviously stories of investors who struck it big in their predictions of major economic downturns, but this is a strategy most investors should avoid.

I wrote an article on LinkedIn back in December of 2018 highlighting the data that illustrates the damage investors can do to their wealth by trying to predict when to get in and out of the market (click here). The problem with timing the market lies in the fact that the worst days to be invested are often followed by some of the best. Just missing the 10 best days causes your returns to be significantly lower than the person who just remained calm and invested.

Closing

One of my favourite investors to follow is Howard Marks.  Marks has been at this game for a very long time (50+ years), with an exceptional track record.  He uses the analogy of a car's gas and brake pedal.  There are times in the market where based on what's occurring that you can push the gas a little more than you normally would and try to be more aggressive.  Then there are times when you should be pressing the brake and moving forward with caution.  Putting the pedal to the metal or slamming on the brakes is never a recommended way to drive. Nor is it a recommended way to invest. Markets are high today, but not insanely high considering the low interest rate environment we're in.  There is no rule when it comes to investing that says a recession MUST occur at a specific time.  And likely the next recession won't be like the last.  

Today investors are faced with slowing global growth, geopolitical risks, large amounts of corporate debt, ongoing trade disputes, and a Brexit debacle. All the while the economy continues to chug along on fairly good footing. If we're using Marks' analogy of the gas and brake pedal, likely we're at a time where some braking is recommended, but that doesn't mean slam on the brakes altogether. As mentioned previously, for long-term investors recessions are an opportunity to rebalance portfolios and put money to work in great businesses at discount prices.  Buying companies at discount puts you in a better position to earn above average long term returns.  For short term investors who need money from their investments to fund retirement, now may be a good time to review your holdings and ensure your financial plan factors in the possibility of recession and how that may affect your future plans.

- Brandt Butt, Investment Advisor, CIM

Brandt Butt is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Brandt Butt who is an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.

[1] https://www.washingtonpost.com/business/2019/09/06/is-another-recession-horizon-google-search-data-has-some-clues/ [2]https://www.nber.org/cycles/