The slowest of slow moving trains finally arrived into the station a couple of weeks ago, when it was confirmed that the UK economy is now officially in recession.
Recessions are a fact of life for investors. It is inevitable that during a, say, forty year investing career you will have to negotiate your fair share of economic slowdowns.
Since 1900 there have been ten recessions in the UK, if you include the current one, so one on average every twelve years or so. You could say that we have been a little unlucky over the past twenty years with three during that time and one of those, the Great Financial Crisis, being a real classic of the genre.
Each recession will have its own characteristics and narratives, but they are not in and of themselves an aberration. They are a necessary staging post within the economic cycle. This is important to remember, because you are probably going to read some real grade A guff on this topic over the coming weeks.
Lots of ink has been spilt elsewhere by far more intelligent folks than I as to why we have ended up in this spot - and I’m not going to recap these here. The fact is that we are.
History tells us that stock market drawdowns during recessions tend to be a) larger and b) longer in duration than those that occur outside of recession.
Again since 1900, S&P 500 drawdowns during US recessions have been -40% and lasted 24 months on average. Bear markets that have occurred outside of recessions have been comparatively less stressful, with the average drawdown being -28% and duration being 8 months.
So it is natural for us to be a wee bit fearful whenever these inevitable resets arrive - the odds are that the market reaction won’t be pretty.
But if you are hoping to invest with the strategy of avoiding recessions - here is the fairly major problem that you have. Stock markets are forward looking, and economic data is backward looking.
What do I mean by this? Well take the recent announcement that confirmed that we are now in a recession in the UK. A recession is most commonly defined as two periods of negative economic growth - and that means that the current recession started in July 2023.
Without wanting to state the obvious, it is currently the tail end of February 2024 and we are therefore now almost eight months down the line from that date.
Short term stock market performance represents the aggregate opinion of hundreds of millions of investors around the world of what the future is going to look like.
It is the role of these investors to sniff out slowdowns before they occur, and therefore by the time a recession is announced, it is usually too late. The market will have already fallen.
The cheerier message however is that the same is true on the other side as well. By the time that it is confirmed that the economy has returned to growth, and the recession has ended, the market has usually bottomed and is well on its road to recovery.
Source: MSCI. The stock market index used is the MSCI World Index. Recessions are US Recessions.
We have seen in the past how the best short term stock market returns tend to occur shortly after the market bottoms. Therefore if you decide to sell on news of recession and wait until “the dust has settled” to reinvest and get back in, you will likely miss out on a huge chunk of the recovery.
Predicting whether a recession is going to arrive or not is an incredibly difficult endeavour. Some of the brightest people on the planet have demonstrated a total inability to do so.
It was considered a done deal last year that the US economy would be in recession by now, and guess what? Hasn’t happened.
If you have some edge that you think gives you an ability to see a recession coming, that’s cool. But I would urge you in the strongest possible terms against making root and branch changes to your investment strategy based on this, or any worldview frankly.
Why? Well let’s assume for a moment that we are both capable of great insight and knew in advance that the UK was going to enter a recession on the 1st July 2023. Knowing, as we do, that the biggest stock market falls tend to take place during recessions - we sold all of our equity investments in order to protect ourselves. Arguably, a perfectly logical decision.
Since the 1st July 2023, the MSCI World index (the global stock market) is up by 13.5%.
History is littered with examples just like this, where logical decisions get punished by markets that don’t behave the way that we might expect them to.
Investing is hard.
There is no such thing as the perfect investment strategy. It doesn’t exist.
Every single strategy that any of us can adopt will have its shortfalls and require inherent compromises. The important part is to recognise and understand what these compromises are at the outset, so that we can accept them and get (relatively) comfortable with them.
The reason that I am a fan of adopting a buy and hold approach is that the primary compromise that we will have to make (sitting through inevitable periods of temporary drawdown) is well known and understood in advance. We have extensive data from over a hundred years of market history to tell us what to expect so there shouldn’t be any major surprises.
The other main drawback with buy and hold is that it is boring, and doesn’t make either of us feel very clever. But that’s fine by me, if it’s fine by you.
But adopting a buy and hold approach means fewer decisions. And we have seen that making, even perfectly logical decisions, can have a detrimental impact to our returns.
Adopting a buy and hold approach also frees us of any need to play the prediction game.
And what a wonderful by product of adopting this time proven method of building wealth, that we get to spend less time thinking about the economy/politics/markets - and more on what really matters to us.
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