2008…what a year. I’m not sure whether to call it a year to remember or a year to forget. The US stock market was down almost 40% while international stocks lost even more. If there ever was “blood on the streets,” it was in 2008.
To make things worse, the National Bureau of Economic Research (NBER) “determined that a peak in economic activity occurred in the U.S. economy in December 2007” and the start of a recession. While the damage to our investment portfolios is already done, we can learn about investment returns during recessions so that we don’t perpetuate the same mistakes we made in the past. Here are some common questions physician-investors may be asking about investments and recessions:
What is a Recession Exactly?
We all know that a recession is a contraction in the economy. It’s most commonly defined as two consecutive quarters of decline in the gross domestic product (GDP), which is an annual measure of newly produced goods and services within the country. The NBER defines it more broadly as a “significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators.” Since 1945 there have been 12 recessions with the average recession lasting less than one year while expansions have lasted nearly 5 years. There have been recessions without the usual two negative quarters in economic output.
How Accurately Can We Forecast a Recession?
Much like physicians stratifying the risk of coronary artery disease in chest pain patients, economists rely on a myriad of data to determine whether a recession is imminent. You may have heard of the index of leading economic indicators (LEI) in the financial media since it’s often cited as a harbinger for recessions. Since 1950 every recession has been preceded by a decline in the LEI index. While it’s tempting to use the LEI index and other economic data as a method of shifting your portfolio out of stocks prior to a recession, it’s actually not that easy. There is typically a long lag time between a drop in the index and the onset of a recession, ranging from a few months to as long as 18 months. At which point do you pull the trigger and dump stocks? Second, there have been a few false positive signals: the index has declined a few times without being followed by a recession. The index declined in the mid 1980s but no recession followed. Can you imagine selling everything and missing one of the greatest bull markets in history?
To learn more about how to invest wisely during a recession, check back for part II of this series next month.
Setu Mazumdar M.D. practices EM in Atlanta, GA and has passed the CFP® Certification Examination