If you and the next recession are both typical, you won’t be aware that it has started, won’t know when it ends and your investment returns won’t be all that bad.
That is, returns won’t be all that bad if you don’t churn up costs and losses by trying to time your market entries and exits.
Embracing your cluelessness, and doing nothing, may be your best option.
There are plenty of reasons to worry about the health of the US expansion and the possibility of a 2016 recession. Business activity among US manufacturers has contracted for the second month running, according to a survey from The Institute of Supply Management, while industrial production is down 1.1% year-on-year.
News from the corporate sector is also dreary: earnings per share at S&P 500 companies are contracting at a 15% year-on-year clip, and sales growth is down 3%. Add to all of this a strong dollar and a Federal Reserve which is in tightening mode.
So, while there are reasonable grounds to worry, the more legitimate question is what, if anything, investors ought to be doing about it. If we reflect on history and are honest about our abilities as market timers the answer, almost certainly is: very little.
Daddy, how did our money do in the recession?
Don’t get me wrong, recessions are lousy times for investors. The S&P 500 lost more than a third of its value the last time round, between December 2007 and June 2009. Across the 14 recessions since 1929, the average loss for that index is 4.3%.
Take a step back and the view isn’t quite so bad. A balanced 50/50 bond/equity portfolio usually weathers recessions relatively well.
“The average real returns of such a portfolio since 1926 have been statistically equivalent regardless of whether the US economy was in or out of recession,” according to a study by Vanguard which looked at data from 1926 through 2011.
During recessions, average balanced portfolio annualized real returns are 5.26%, just a fraction below the 5.59% seen during expansions.
To be sure, this time may well be different, especially as, with 10-year Treasury yields at 2.25%, there is less room for a bond rally to serve as compensation for the typical fall in equities. Yet, during only four of the recessions dating back to the big one beginning in 1929 have real returns for a balanced portfolio been negative.
They don’t ring a bell
So while returns will be worse while the recession is on, you very likely won’t know when it started in order to lighten up on risky stocks. You are even less likely to be able to pinpoint when it is over and the time is ripe for reinvestment.
That’s not to say recessions aren’t scary and damaging to wealth, only that your ability to insulate yourself is very limited.
They don’t, after all, ring a bell to start and end a recession. Instead, they, meaning all of us, are constantly both ringing bells and imagining we hear them. Even the experts at the National Bureau of Economic Research, the official timekeepers of recessions, are often six months or more late to declare that one has begun. The last recession, which began in December 2007, was only declared by NBER a year later.
So if the experts can’t get it right, why will an average investor? A look at consulting firm Dalbar’s Qualitative Analysis of Investor Behavior study does not hold much hope. Dalbar has, for the past 21 years, been collecting data on how mutual fund investors’ real-life returns compare with market returns.
The results are not pretty. In the most recent survey, covering 2014, the average equity mutual fund investor lagged the market by 8.19 percentage points, earning just 5.5% in a strong year. Bond investors don’t do better, earning just 1.16% that year compared to the Barclays Aggregate Bond Index which returned almost 6%.
And it isn’t just a 2014 thing. Over the 20 years to end-2014, equity mutual fund investors lagged their benchmark by 4.66 percentage points a year. Dalbar attributes the poor results to lousy market timing by investors.
Putting it all together: recessions are hard to time, investors are bad at timing and the penalty for just sitting there and taking your lumps is not so bad.
There are good reasons to adjust portfolios, but those have to do with how your portfolio compares to your personal risk profile. The fear of a recession may put you in mind of your personal risks, but you should already be invested with those in mind.
Sitting on your hands and watching recessions come and go in their wayward and unpredictable way is probably your best bet.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
