Intelligent Design

John McMillen | Portfolio Manager

Learn what matters - and what doesn't - when building a sound investment strategy.

Market Timing a Recession

December 2008

The big news last week was the official announcement by the National Bureau of Economic Research (NBER) that the economy has been in a recession since December 2007. Many investors who have not yet bailed out of the market will no doubt interpret this as a clear sign they should now.

Is their premise correct?

Given that we now know where we have been (in a recession), I thought it would be informative to see how the market performed during these official recessions and how an investor with perfect clairvoyance would have performed if he was able to avoid them. 

The table below shows the official Business Cycle Reference Dates and their durations as reported by the NBER using the most recent data capturing 32 years of economic activity (1969-2001), which encompassed six recessions: 

BUSINESS CYCLE
REFERENCE DATES
DURATION IN MONTHS
Peak
Trough
Contraction
Expansion
Cycle
 
Peak
to
Trough
Previous trough
to
this peak
Trough from
Previous
Trough
Peak from
Previous
Peak
December 1969
November 1973
January 1980
July 1981
July 1990
March 2001
December 2007
November 1970
March 1975
July 1980
November 1982
March 1991(I)
November 2001
11
16
6
16
8
8
106
36
58
12
92
120
73
117
52
64
28
100
128
116
47
74
18
108
128
81
Source: NBER

Since 1969, the average recession, peak-to-trough, has lasted 10.8 months, with none lasting longer than two years. Meanwhile, the average expansion lasted 5.91 years. Though certainly some recessions were longer and more severe than others, all were unique to their time, something no different than today. Be they triggered by war, oil, inflation or credit, all economic crises share the common ability to strike fear and anxiety in investors as to what the future may, or may not, hold.

Now let’s suppose an investor had magically been able to identify the peaks and valleys of the business cycle ahead of time, exiting the market at the peak of economic expansion and re-entering the market at the trough of economic recession. The following table shows the gains or losses that investor would have missed out on during the time they were out of the market: 

Start
Trough
 
Total Return
December-69
November-70
-3.45
November-73
March-75
-12.99
January-80
July-80
16.14
July-81
November-82
10.13
July-90
March-91
7.64
March-01
November-01
-7.18
December-07
?
 
Total Return
 
7.36
Total Annualized Return
0.22

It may surprise you to see that the cumulative return for the market during those six recessions was actually a gain of 7.36%! Any investor who had been “lucky” enough to avoid all of the past six recessions would have actually given up about a quarter-percent annually had they not been invested.  

How is this possible? Being a leading indicator of the economy, the market historically generates significant positive returns before the recession is over. The stock market has a long history of turning in the midst of what appears to be the darkest of times. Though the figures above do not include the current economic downturn (as we do not know exactly when this will end) the simple fact is despite just about every economic shock one can think, the stock market delivered an annual return of 9.29% from December of 1969 to the end of November 2008.  

As bleak as it may seem now – and it may well get bleaker – it will be those investors who do not succumb to fear and remain patient and committed to a long-term disciplined strategy who capture the market’s risk premium and the positive returns that come with it. 

Email A Friend Print This Article