A sharp decline in the stock market is often an indicator of an impending recession – that is, a temporary period of economic decline. With the S&P 500 Index falling 1,000 points, or about one-fifth, from January through June, a consensus is emerging that a recession is coming, perhaps next year.
Recessions have wildly varying durations and depths. The official judge is the National Bureau of Economic Research, which counts nine of them since 1960, lasting an average of about a year. Recent recessions have been the result of severe shocks to the system: the 2008 financial crisis and the 2020 pandemic. The COVID recession was the shortest in history (two months) but the most intense (gross domestic product down by nearly one-third).
A 2022 or 2023 recession will be very different. If it happens, it will follow a more traditional pattern, triggered by the Federal Reserve Board raising interest rates sharply as a way to reduce consumer and business demand to tame inflation. For investors, there are three important facts about recessions:
- They are uncertain. The Fed raised rates nine times from late 2015 to late 2018 without triggering a recession. Nobel Prize-winning economist Paul Samuelson once famously quipped that the stock market had predicted nine of the last five recessions. Economists have a poor record, too, though two-thirds of them, including Samuelson’s nephew Larry Summers, expect one next year.
- They end. This is a critical point for long-term investors, who should keep buying stocks on a regular basis. Using a process called dollar-cost averaging, you can invest a set amount at regular intervals – when stocks are cheaper, you can afford more shares.
- They deliver opportunities. Finally, there is little shelter in the stock market from recessions, but at the same time, they offer remarkable opportunities.
If you have a reasonably diversified stock portfolio, it has likely lost roughly 20% of its value during the first six months of the year. Those losses anticipate a recession – or at least a very rough patch for businesses. The hit has been felt across the board, with the exception of the energy sector, which has benefited from oil and gas shortages caused by the war in Ukraine and the spike in demand as the pandemic economy reopened.
Healthcare, consumer staples and utilities – that is, things that consumers can’t do without, even in a recession – have fallen the least, on average about half as much as the rest of the market. These are the classic sectors for safety.
If you are worried about a deep and prolonged recession, consider stocks such as Merck (MRK), the pharmaceutical giant. Merck shares are actually up this year, and analysts see profits holding steady through 2023. The …….