Camille Van Vyve
13 Oct 2022
What is a recession and how do you deal with it?
The specter of recession haunts our news wires, our newspapers and our televisions. Specter is the word: the thing frightens at the same time as it is elusive. But recessions have always existed, and markets have almost always anticipated them. Armed with this experience, the investor can, if not protect himself against it, at least face the situation with composure.
What is a recession?
A recession is a period of temporary setback in a country's economic activity. Most often, we speak of a recession if we observe a decline in the Gross Domestic Product (GDP) over at least two consecutive quarters.
We only realize it afterwards
Given this definition, one can only officially speak of a recession when it has already taken place – that is, when economic growth has been negative for two consecutive quarters. As a result, as an investor, it is very difficult to anticipate recessions.
How long do recessions last?
Recessions are an integral part of history. Since 1857, recessions have occurred on average every 39 months and last on average 18 months. If we observe a shorter period starting after the Second World War, the frequency and duration of recessions tends to decrease: the phenomenon occurs since then almost every 5 years and lasts a little less than a year on average.
Markets anticipate recessions
The evolution of the financial markets has shown in the past that the stock markets anticipate periods of economic decline that are recessions. Most often, we observe a stock market peak 4 months before the recession, followed by a precursory drop.
Markets anticipate…everything
In reality, the markets anticipate most important events, whether the outcome is positive or negative. We saw it with the rise in rates: the markets had priced it in before it even happened, adjusting prices downwards before central banks actually raised their rates. On a more positive note, we regularly read that the markets “anticipate good employment figures in the United States” or “anticipate good results” from such and such a company.
Thanks to collective intelligence
How can we explain the ability of markets to anticipate? In particular by what is called the “wisdom of the crowd” or collective intelligence. This theory proves that in apprehending a problem, a large number of amateurs will always be more efficient than any individual, even an expert, as long as their opinions are varied and independent of each other. This theory supports the other major market efficiency theory. Even if both are not infallible (due to cognitive biases among other things), they explain a large part of the functioning of markets.
Invest in a recession
Since the markets tend to anticipate everything, they generally also rebound before the end of crises. For the investor, this means that you don't necessarily have to wait for the situation to improve to start investing. On the contrary: in order to take full advantage of the rebound, it is better to invest when the market is at its low point.
The years after recessions are often the best
The advice is even more useful since after a setback, the markets tend to rebound sharply. Indeed: for each year starting 6 months before the end of the recessions represented on the graph above, the S&P 500 rose by more than 10% on average. Investing or staying invested during a recession is therefore the best thing to do in order not to miss the coming rebound.