Currently, talks of a recession seem to be dominating investment discussions. Rising inflation and interest rates, continued China lockdowns and the war in Ukraine are all having (or have had) a negative impact on world growth. So, we thought it might be timely to talk through what a recession is, what it might mean for future growth and the long-term impacts on investment markets.
What is a recession? (courtesy of the Reserve Bank of Australia)
There is no single definition of recession, though different descriptions of recession have common features involving economic output and labour market outcomes.
The most common definition of recession used in the media is a ‘technical recession’ in which there have been two consecutive quarters of negative growth in real GDP. This definition often appears in textbooks and is widely used by journalists.
A recession can also be defined as a sustained period of weak or negative growth in real GDP (output) that is accompanied by a significant rise in the unemployment rate. Many other indicators of economic activity are also weak during a recession. For instance, levels of household spending and investment by businesses are usually low.
What would a recession mean for investment markets
Recessions are painful, but they are necessary to clean out the excesses of prior growth periods, especially the more or less uninterrupted growth investors have enjoyed over the past decade.
In his recent midyear update to investors, Capital Group’s Rob Lovelace noted “You can’t have such a sustained period of growth without an occasional downturn to balance things out. It’s normal. It’s expected. It’s healthy.”
The global economy certainly appears headed in that direction. Europe is potentially already in a recession, exacerbated by the war in Ukraine. China’s growth has decelerated essentially to zero, pressured by rolling COVID lockdowns. And the US economy, while stronger than most, appears headed for a significant downturn as elevated inflation and higher interest rates take their toll.
The important thing to remember, recessions are inevitable but the pain doesn’t last forever as recessions often set the stage for the next period of growth.
Shares typically recover before a recession ends
Sharemarkets usually start to recover before a recession ends. Shares have already led the economy on the way down in this cycle, with nearly all major equity markets entering bear market territory by mid-2022 (a bear market is a fall of more than 20%). If history is a guide, they will rebound about six months before the economy does.
The benefits of capturing a full market recovery can be powerful. In all cycles since 1950, bull markets had an average return of 265%, compared to a loss of 33% for bear markets.
The strongest gains can often occur immediately after a bottom. Therefore, waiting on the sidelines for an economic turnaround is not a recommended strategy.
What does it mean for your portfolio?
The Muirfield Investment Philosophy takes a long-term view of investing. Therefore, we expect there will be periods when markets and portfolio’s go backwards. We encourage clients to try and take a long-term view during these times. As the table below shows, a bear market, on average, is shorter and less severe than the subsequent rebound.
So, whilst it’s never nice to see your portfolio balance go backwards, we are hopeful that markets will rebound and hit new highs in the future.
Source: Capital Group (data includes all completed cycles in the US from 1/1/1950 to 31/10/2022)
We hope you all have a great festive season with loved ones and we look forward to assisting you in 2023.
As always, if you wish to discuss your situation in more detail please contact our office and arrange a discussion with your adviser. However, please note our office will be closed from the 23 December to 9 January 2023.