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Recessions are rarely more than a non-event for long-term investors

Lukas Daalder Although stocks usually go down during a recession, they often recover well afterwards, says Lukas Daalder, Chief Investment Officer of Robeco Investment Solutions.

Speed read:
  • There hasn’t been a major recession in the US for the past six years now
  • Recessions are not necessarily bad for stocks if they take place within three-and-a-half years
  • Post-recession euphoria should be enough to compensate for the initial losses

It's been around six years since the last US recession – which is more than just a coincidence. Recessions (the gray areas in the graph below) now occur far less frequently than they did a hundred years ago and, on average, don’t last as long either. This isn't just a happy coincidence; it’s the result of a cocktail of factors, suggests Lukas Daalder, CIO of Investment Solutions. The most significant of which is the more accommodative central bank monetary policy – a direct result of the abolition of the gold standard. “That has definitely had an effect on the economic cycle. In addition, in the last few decades more and more people have embraced Keynes' vision that governments can steer their economies." This can be seen in figure 1.

Recessions are rarely more than a non-event for long-term investors 
Source: Shiller database and Robeco

The social safety net for people who lose their jobs also helps to flatten out the economic cycle. Another reason why there are less shocks in the cycle is that better data is available to companies, which enables more efficient inventory planning. “In the past, the trade cycle was a result of over-investment in real estate, machines and inventory. When demand slumped, everything was put on hold, which caused huge swings in the economic barometer. Significant mismatches between demand and supply are less frequent nowadays."

Although there are more factors that have contributed to the fact that we have fewer recessions, it is tempting to conclude that the freer hand the central banks have been given is proving successful. But this conclusion does have its risks, says Daalder. “The purifying effect of recessions has partially been eliminated, helping to sustain entities where performance is mediocre or even poor. This is also seen as one of the reasons why we are now faced with disappointing growth."

The question though is whether we really do miss the purifying effect of recessions. And whether this really always occurs. Japan is a classic example of an economy where recessions occur from time to time, but don't lead to bankruptcies, for example of banks suffering with mountains of non-preforming loans – as these are kept afloat.

Afraid of a non-event
Investors have now developed a pathological fear of recessions, but the reason for this is hard to explain when we look at the hard figures. Historically equity markets fall in the three months prior to a recession and in the first eight months of the recession itself. However, they then quickly recoup their losses and within a year and a half (on average) these are completely eradicated. So that should not form an insurmountable obstacle for long-term investors.

Aren't recessions then actually just a non-event for investors who are in it for the long haul? On average this is true, but the crux of the matter is in the word 'average' says Daalder. “On average recessions do not wreak irrevocable damage and the losses are wiped out relatively quickly, but in 2008-2009 things were very different, both in terms of stock portfolio losses and the time it took to get back to pre-recession levels. And at the beginning of a recession you don't know if it will be a mild correction or one like 2008-2009."

It is always difficult to prepare for a recession. Predicting them (and advance positioning) is an impossible task and when things do actually start to happen, often it is already too late to take action. An additional problem is that the most reliable recession data comes from the United States and historically the US market is seen as the strongest in the world. “This means that studies that use data from the US often have a certain bias, which can result in overly positive conclusions," says Daalder. “2008 is again a good example of this. US equities were already back at pre-crisis levels while many European markets were still busy trying to recover the damage."


Lukas Daalder

Lukas Daalder

CIO Investment Solutions
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Lukas Daalder
CIO Investment Solutions


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