Clients of Henry Wealth Management are asking, or at least wondering..."based on the Fed increasing interest rates in an attempt to tame inflation, are we headed for a recession? If so, how will this impact my portfolio?
First of all, the common definition of a recession is two consecutive quarters of declining GDP. Yet in terms of your portfolio, it might not matter whether we are "officially" in a recession or not. The reason is, unlike GDP, the stock market is forward-looking. To be forward-looking means that investors begin to price-down stocks before the economy sinks into a recession, and conversely, begin to price-up stocks well before the economy recovers and a recession is declared to be over.
On a YTD basis, we have already experienced a significant drop in stock prices, and this was before an official "Recession 2022" label has been applied. Likewise, we should also expect stock prices to rise when investors anticipate better times ahead, before we actually get there.
If and when a recession is declared, that doesn't mean that your portfolio will be further doomed. Considering data covering the past 15 US recessions, investors tend to be rewarded for sticking with equities. In 11 of these past 15 instances, returns on stocks were positive two years after a recession began, averaging 7.8% per year over the next two years.
Most recently in 2020, we experienced the shortest recession in the past 100 years! In early 2020, the US stock market tumbled more than 20% (which is the definition of a 'bear market') as investors dealt with grave uncertainties at the onset of the global pandemic. However, investors who stuck with stocks experienced a sharp and unexpected rebound, beginning in April of 2020. This upturn occurred even as the COVID 19 death toll was rising, as mask, work-from-home and school-from-home mandates were initiated, and as college and professional sports seasons were cancelled.
So while many were negatively impacted on an emotional level during the lockdown stretch, our stock portfolios were being positively impacted. Stocks, as measured by the Fama/French Total US Market Research Index, rebounded from an awful first quarter, to gain 24.1% for the full 2020 year (see Market Returns Through a History of Recessions). This is an important reminder that intra-year declines don’t necessarily translate into calendar year declines.
Speaking of bear markets, from 1926-2021, the S&P 500 Index has experienced 17 of them! The average length of these bears was 10 months. While 17 bear markets sounds daunting, the S&P 500 Index still returned an annualized 10.46% from 1926-2021. That means $1 invested in the S&P 500 Index on 1/1/1926 would have grown to over $14,000 by the end of 2021.
Finally, from a historical perspective, US equity returns following sharp downturns, have on average, been quite positive. Check out the "Bouncing Back" chart below, which illustrates from 1926, US equities have delivered positive returns on average, over 1-, 3-, and 5-year periods after market declines.
Sticking with your plan, or as we like to say, "building a portfolio you can live with, and then living with it", helps put you in the best position to participate in a recovery. While we can’t control things like Inflation or what the Fed does, we can control our behavior. As we have seen time and time again, reacting to a downturn is usually hazardous to your wealth, while building a portfolio that you can live with and then living with it, even through a downturn, has been beneficial to your wealth.