An important concept for investors to grasp is that stock markets don’t go up and down, hand in hand, with the health of the economy. Why? Because although markets respond to the very latest information, it often takes time for that information to become available. As WES CRILL from Dimensional Fund Advisors explains, economic recessions are a good example. Because recessions are proclaimed with a delay, rather than in real time, markets are often on the way toward a recovery by the time they’re actually announced.
Just two years removed from the last US recession, negative stock returns and aggressive US Federal Reserve interest rate hikes have many investors concerned we are headed for another big “R” — if we’re not already there. But recessions are always identified with a lag. By the time one is called, the worst of its impact on markets has usually passed.
The National Bureau of Economic Research (NBER) identifies phases of the business cycle using a bevy of indicators, such as consumption and income data, employment rates, and gross domestic product growth. None of these measures has been consistently dominant in the determination of economic conditions, and certainly past US recessions have come in all shapes and sizes. Recessions are therefore named retroactively, with the benefit of hindsight (and additional economic data that may be available with a lag).
Because recessions are proclaimed with a delay, rather than in real time, markets are often on the way toward a recovery by the time of the announcement. As shown in Exhibit 1, the stock market had already bottomed out prior to the announcement month in two-thirds of recessions since 1980.1 In 2020’s recession, for example, the market’s low point came in March, three months before the announcement in June 2020. The takeaway for investors? If and when a recession is declared, we think the most sensible approach is to remain disciplined with one’s asset allocation; reducing exposure to stocks at that point may lead to missing out on brighter days ahead.
1 Prior to 1979, the NBER did not formally announce recessions.
This material is in relation to the US market and contains analysis specific to the US.
The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmitting of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing or other such legal requirements within the jurisdiction.
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
WES CRILL is Head of Investment Strategies and Vice President at Dimensional Fund Advisors.
This article first appeared on the Dimensional Fund Advisors blog, Dimensional Perspectives.
PREVIOUSLY ON TEBI
© The Evidence-Based Investor MMXXII