My article from last week, which you can read here, prompted a few people to ask derivations of, “Why don’t we sell our stocks – or at least reduce them – until the recession is over and sidestep some losses?”
It’s an understandable question, but it makes me uncomfortable because I have some powerful memories of the 2008 global financial crisis when clients who bailed out of the market still felt incredibly uneasy.
It was almost a year from the top of the market in 2008 to the moment that Lehman Brothers went bankrupt, and some clients had enough and sold out against my advice.
I didn’t blame them – it was a pretty scary time; the one year of losses felt like an eternity, it was hard to see how we would get out of the morass we were in, and no one could tell where the bottom would be (it wasn’t for another five months, which felt like another eternity).
I assumed that once people were out of the market, they would feel relief because they couldn’t lose anymore. I was wrong. As I remember, they started worrying about when to get back in and felt anxious about the possibility of missing the recovery.
And with good reason, many did not get back in in a timely way and missed a lot of the upmarket that followed. A few never got back in and missed one of the best decades on record.
Last week, I also promised to look at market returns going into, during, and after recessions. The results are interesting.
I started with the average monthly market return from 1950 to avoid the Great Depression. I always feel a little awkward leaving it out because it happened and mattered in a big way, but this is a look at recessions, not depressions. The average return during that period was 0.98 percent.
Then, I divided the returns into four groups. The first group was the returns during recessions defined by the National Bureau of Economic Research (NBER), the official referees for dating them.
You can only calculate this with the beauty of hindsight because the NBER doesn’t tell you when a recession starts or ends until well after it’s over.
The average monthly return during recessions was 0.30 percent – still positive, but 70 percent less than the average of all months.
(For you technical geeks out there, the standard deviation of the monthly returns in recessions was 6.0 percent, about 40 percent more than the 4.2 percent seen in the overall sample).
The next group was the average return for the six months heading into a recession. The average return is negative, at -0.03 percent. This makes sense because the market is pricing in the likelihood of a recession, and the impact may be on stocks, suggesting that the market is forward-looking.
It’s also cheating a little because we know the exact recessions and therefore exclude all of the bad periods in markets that don’t turn into recessions. Still, it’s interesting.
Most interesting, though, is the third group, which is the six months following a recession. The average monthly return is 1.93 percent, which is almost double the average return for all of the months. It’s what the clients who got out of the market were worried about missing, and rightfully so.
The last group is any month that wasn’t six months before a recession, in a recession, or in the six months following a recession. The average here is 1.1 percent, which is not dissimilar from the entire sample set.
The trouble with this analysis is, as I’ve noted, we don’t know when recessions occur until they are over. I’m still not convinced we are in a recession now but are we within six months of one? That could be, I don’t know.
The not knowing is why we have adopted our ‘buy-and-hold’ approach, where we set an allocation based on your circumstances when there is no crisis going on and set it to writing in an Investment Policy Statement (IPS).
We talk about how much you might lose based on statistics or what you would have lost in a previous bad market like 2008, not knowing what we may encounter in the future, but knowing we will encounter the down markets that come along with the up ones.
Like everyone else, I don’t know where we are headed next, but I do know that there will be an end to this, and we will recover, just like we have from every bad period in the past.
My primary hope right now is that people stick with their allocations or adjust them ever so slightly if they can’t sit still and wait for this to pass. It’s not easy to do, but we think it’s the right approach for the long run, especially after seeing what happened after 2008.