How to Think About Investing During a Recession

By Charlie Bilello

11 Aug 2022

Is the US economy in a recession?

Everyone seems to be asking that question.


Likely because we just learned that real GDP contracted for the second straight quarter. And the last 10 times we’ve seen consecutive quarters of negative economic growth, the US was indeed in a recession.

Note: Recession column as defined by NBER

With data going back to 1947, we’ve never seen a 2-quarter decline in real GDP of this magnitude (-0.63%) without the US being in a recession.

Still, many are not convinced, pointing to the jobs data which continues to be strong. The US Unemployment Rate has moved down to 3.5%, back to pre-pandemic levels and at a 53-year low.

And so, the heated recession debates will likely rage on until we get an official announcement from the National Bureau of Economic Research (NBER) or see a sharp turnaround in growth.

All of which is creating further angst among investors, who have already faced the most difficult start to a year in recent history.

And angst is not a particularly good emotion to have, as it tends to precede actions (like panic selling) that can be deleterious to the long-term health of your portfolio.

Which begs the question: what should an investor be thinking about as it pertains to recessions? Here’s a few things to consider…

1) Recessions Happen

Since 1871, there have been 30 recessions in the US, averaging one every five years. And in spite of that fact, the S&P 500 has gain 6.9% annualized over that time, after adjusting for inflation. There’s been no better long-term builder of wealth in the last 150 years, and recessions are a necessary part of the package, for there’s no upside in investing without intermittent downside.

2) Timing Isn’t Everything

Still, wouldn’t it be better to sidestep recessions and related stock market downturns altogether? It certainly sounds tempting.

Let’s say you were the best economist that ever lived. You knew exactly when recessions would start and end in advance, moving to cash (3-month Treasury bills) during recessions and stocks only during expansions.

What would your returns have looked like since 1928?

10.7% per year versus 9.7% for buy-and-hold.

Not bad, until you dig into the data and see that all of this outperformance came from avoiding the bulk of the losses during the Great Depression (when stocks declined 86%). Since the Depression, if you were able to time every single recession perfectly, you would have had underperformed with a 10.6% return versus 11.7% for buy-and hold.

In reality, no one could’ve predicted every recession with such precision. Let’s say instead that you were early in getting out, moving to cash a year before the recession and getting back into stocks a year after it ended. Or more likely, let’s say you were a little late and moved to cash six months after a recession started and moved back into stocks a year after it ended.

That would still be pretty remarkable timing. How would these scenarios have fared? Worse than a simple buy-and-hold, and this is not factoring in transaction costs and taxes, which would skew the results further in favor of doing nothing.

How can that be?

The stock market is not the economy. It often starts going down before the economy turns south and starts turning back up before the downturn ends. Getting that timing right on both ends is nearly impossible, and in trying to do so you’re likely to cause more harm than good.

3) Don’t Wait for the Robins

Maybe you can’t time a recession, but why should you invest new money when the economy is contracting? Wouldn’t it be better to wait for the news to improve and the downturn to end before adding to your portfolio?

Historically, the answer has been a resounding no.

During the last 6 recession, the S&P 500 has gained an average of 61% from its low by the time the official end of the recession was declared by NBER.

In October 2008, during the worst recession the US had experienced since the Great Depression, Warren Buffett famously penned an op-ed entitled “Buy American. I am.” He made the case for investing in equities despite all of the terrible news of the day, saying that if you “wait for the robins, spring will be over.”

4) Stay Diversified and Don’t Fight the Last War

During bear markets and recessions, there’s a tendency for correlations to rise, with many assets moving in the same direction: down.

Inevitably, something will buck that trend, and move in the opposite direction. While it’s tempting to abandon your diversified portfolio and go all-in “what’s been working,” that hasn’t been a prudent strategy in the past.

During the pandemic recession in 2020, the Volatility Index ($VIX) spiked to its highest closing level ever by mid-march (82.69), and the VIX futures ETN ($VXX) had more than quadrupled on the year. Naturally, demand for such “hedging” products soared, as investors feared the worst was yet to come.

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But the worst was actually already over, and the $VIX would soon plummet. As volatility declined, so did the $VXX, and those who fought the last war were taught a valuable lesson once more.

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This year, inflation is the biggest concern for most investors, and the only thing “working” has been commodities. Loathed back in 2020 when Crude Oil futures turned negative, the opposite sentiment prevails today as “inflation hedges” have become the most popular vehicles of choice. While having a percentage of your portfolio in assets that may benefit from periods of higher inflation is certainly reasonable, going all-in on a single commodity after a huge runup is not nearly the same thing. Don’t fight the last war.

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But What’s the Answer?

I know what you’re thinking. This may be a prudent exercise for long-term investors to think about, but you still want to know: is the US economy in a recession?

Since there’s no precise formula that the NBER uses, there’s no way of knowing the answer with any certainty. But if you’ve taken away anything from this post, it should be this: from an investment standpoint, the answer doesn’t really matter.

Markets move first, and they’ve already adjusted to an increased probability of a recession with a 23% decline in the S&P 500, 33% decline in the Nasdaq Composite, and many high growth stocks cut in half or more (note: total return using closing prices).

Is that enough? No one knows. We’ve seen recessions in the past where the S&P 500 has declined less (most recent example: 1990-91 recession) and many during which the S&P 500 has declined more (most recent example: 2020).

The one constant is that all recessions and bear markets of the past have ended, with new expansions and all-time highs following at some point in the future. With all the things to worry about today, that should be a comforting thought for long-term investors. Historically, if you stayed the course, you were eventually rewarded. And that’s been true regardless of whether the economy was deemed to be in a recession.

“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.” – Peter Lynch

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