Lessons from past recessions

Mark Twain once said, "History never repeats itself, but it often rhymes."

So it is also with the financial markets. Just because the market or a stock behaved in a certain way in the past, doesn't necessarily mean that it will behave similarly in the future. Investors are frequently bombarded with the common disclosure of "past performance is no guarantee of future results."

This doesn't mean, however, that studying history is a pointless endeavor.

There are patterns and trends that can help investors stay true to their goals and long-term approach. After all, short-term bets against long-term goals can often be a recipe for disaster. Here's a brief look at the three most recent recessions in U.S. history:

The COVID-19 Recession

A global pandemic halting economic activity caused a short but severe recession.

The recession started in February 2020 and ended in April 2020 lasting only about two months. Despite the short timeframe, the S&P 500 during that time period was down about 34%. Quick and heavy response from the Federal Reserve and Congress swung the economy back by the end of the year and the S&P 500 ended the year up 16%.

Sam Watkins, CFP® TrueNorth Wealth

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The Great Recession

Mortgage-backed securities and risky mortgage underwriting practices triggered the global financial crisis.

This was the worst economic downturn since the Great Depression. The recession started in December 2007 and ended in June 2009 lasting about 18 months. The S&P 500 was down nearly 57% during this timeframe.

If you adjust for inflation/deflation, an argument can be made that this market downturn was the worst in modern history, including the Great Depression.

Dot-com Bubble

The excitement surrounding the internet and tech companies around the turn of the century fueled a bubble in technology stock valuations.

When the bubble collapsed, a recession followed, lasting for about eight months from March 2001 through November 2001. Triggered by the collapse of the dot-com bubble the S&P 500 was down almost 50% during the year.

It's clear that recessions come in all shapes and sizes, even when only looking at a small and recent sample size. Despite their individuality, certain patterns emerge from historical data that can be beneficial to investors.

Important data to consider

Since 1857 there have been 34 recessions averaging 17 months long. These recessions varied in length ranging from two months to five years.

Lately, recessions have been less common and shorter in length on average. There have only been six recessions in the past 42 years. Those six recessions had an average length of 10 months. Economists attribute this infrequency and shorter length to an increased understanding of what causes recessions allowing central banks to take more effective action.

Recessions are often preceded by contractionary monetary policy. Contractionary monetary policy can include reducing the money supply through open market operations. By selling securities, the Federal Reserve reduces the money that is circulating in the economy. A central bank can also increase interest rates making business investment activity more expensive thus slowing the economy.

Why would a central bank do this?

The Federal Reserve is trying to keep inflation low and steady while making expansions and contractions less volatile. When the economy is growing rapidly, they might institute a contractionary monetary policy to make sure a bubble doesn't form.

The Federal Reserve is currently engaged in contractionary monetary policy to curb rising inflation—which was partially caused by an expansionary monetary policy with the fight against the COVID-19 recession. As interest rates rise, it affects the multiple of earnings that investors are willing to pay for companies, leading to today's downturn.

Looking forward

It seems likely that a recession is on the horizon at this point. Though many industry professionals might dispute how likely that may be, investors must have a game plan for when market downturns and recessions inevitably come.

It is important for investors to understand that markets and recessions move along different timelines. Since markets are forward-looking, they are considered a leading indicator of the economy.

Historically it has been quite common for the market to start falling well in advance of the beginning of the recession and to start climbing again well before its end. This should tell investors that making investment choices based on the headline state of the economy is often a bad idea. Most people will experience many recessions in their lives and although they are difficult to live through, they should not be viewed as market forecasts that lead to poor decisions.

The consequences of such actions could be catastrophic. Historically, most of the markets' best days have happened during bear markets. If you missed the 10 best market days in the last 30 years because you didn't want to be an investor during bear markets your return was cut in half.

Regardless of whether this is a recession or a bear market, there has never been a time in history when the market has not rebounded and continued to grow.

• After a 20% market decline, the 1-year, 3-year and 5-year average returns following the decline were respectively 22%, 41%, and 72%.
• After a 30% market decline, the 1-year, 3-year, and 5-year average returns following the decline were respectively 24%, 16%, and 50%.

All investment choices are made in a world of uncertainty, and making choices in the midst of a market downturn or economic recession makes those choices doubly agonizing. However, the best way to ensure good outcomes is to decide in advance to follow good investment principles. Decide now to not sell low and to stick to your long-term strategy and rebalance and you will maximize your long-term chances at wealth.

To learn more or schedule a no-cost consultation, visit our website at TrueNorth Wealth or call (801) 316-1875

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