A Necessary Bucket of Cold Water

The markets have been off to a turbulent start for 2022. With the S&P 500 down about 15 percent since its peaks in January, this year marks one of the worst starts for investors since 1970. Any number of reasons may seemingly justify the drop: Federal Reserve actions, supply chain constraints, oil prices, the cost of chicken, etc. The “fill in the blank” looming catastrophe is an ever-present enigma, especially with a 24-hour news cycle. Does it seem, as a society, crises entertain us?

What many people fail to understand is our economy, on occasion, needs to experience a recession. Think back to the 1980s. Similar to our modern environment, we were experiencing a combination of high inflation and self-imposed rising interest rates – rates that were moving ever higher in an effort to slow down red-hot inflation. It wasn’t until we experienced a recession that we “broke the back” of inflation. Remember, higher rates are designed to slow the pace at which prices for goods and services are increasing. Yes, a recession can feel temporarily painful, but if it has the effect of keeping expenses in check, it might be a welcome pain.

Thinking back to the 1980s and that period of “stagflation,” I’m also reminded of the would-be prognosis for the American economy. Voices just as loudly as today decreed the end of American capitalism. It’s a great reminder: this is not the end of days.

When things start to look bad, I tend to look for perspective. The reality is that recessions are fairly common. Since 1980, there have been six recessions, on average once every seven years. The longest was during the global financial crisis (Dec. 2007 until June of 2009), when the GDP declined 5.1 percent from peak to trough. The shortest was the COVID-19 shock recession which lasted just two months (Feb. to April 2020), when the GDP dropped an astonishing 19.2 percent. Remember, the entire country, and for that matter, the entire world, was effectively shut down.

The average duration of these six recessions was just ten months, and the average decline in GDP was about 5 percent. Put into perspective, there are 508 months from 1980 through April of 2022. During those 508 months, the six recessions lasted cumulatively just 58 months. Said another way: 88% of the time, the economy was expanding.

Furthermore, the S&P 500 has been down double digits 21 times since 1980, according to research from LPL Financial. Twelve of those times, the market came roaring back, finishing the year in the green with an average gain of 17 percent.

Like the occasional hurricane, recessions are normal and to be expected. Plan for them.

Remember, planning for a recession does not automatically mean selling equities at a low and rushing into traditionally “safer” investments like bonds. Like equities, bonds have faced choppy waters. With the Federal Reserve raising interest rates, the 20-year U.S. Treasury bond has fallen nearly 23 percent in value since the beginning of this year according to Yahoo Financial. This will come as an ice-cold dose of reality when investors see their statements and the value of what they expected to be “safe.” Yes, you can lose money in bonds. Even worse, bonds pay a fixed return for their duration, which, with inflation at over 8 percent, means your purchasing power is likely disappearing. When the rate of the bonds or fixed income is below the inflation rate, you lose purchasing power on that capital.

For example, as of April 25th, the 10-year Treasury is at 2.78 percent. If inflation is 8.5 percent, you are losing roughly 5 percent of your purchasing power each and every year in an investment that is supposedly “safe.” At that rate, even with the coupon or income from a bond not spent on consumption, your money loses 50 percent of its purchasing power in just 14 years. If you are 65 years old, when you turn 79, the money in fixed income may only buy you half the goods and services it does today. That’s a good way to grow poor slowly.

Recessions are a necessary and often painful reality for investors. But rather than be swept up in the noise of impending disaster and gloom, remember that they are normal. An optimistic perspective is far more often the correct perspective, even when based solely on the data. The cure is not worse than the disease. We’ve all seen this movie before, and we know the ending. Prepare for recessions, take advantage of them, and do not be fearful.