Why It Doesn’t Matter If You Accurately Predict A Recession

THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE READ MY DISCLOSURE FOR MORE INFO. 

 

It feels like you can’t go a day without reading the news about an impending recession.  They say it will wipe out swaths of wealth.  All of the so-called experts are shouting from the rooftops that investors should take money out of the market and into perceived safer assets.  They are fueled by fear and by the uncertainty of what will happen with the imminent doom.

 

What is a Recession?

Before I go too far, I think it’s important to clarify very quickly what a recession is.  Some people view a recession when the stock market goes down by 20%.  This is incorrect.  When the stock market goes down by 20%, that is actually called a bear market.  In contrast, when the market goes up by 20%, it’s considered a bull market.  

 

Currently, the U.S. economy has been in a bull market since March of 2009.  Meanwhile, the GDP (Gross Domestic Product) is currently in an expansion.  The GDP is a measure of the total value of goods produced and services provided in a country during one year.  An expansion is when the GDP continues to increase year over year.  

 

A recession is “a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.” (Oxford Dictionary)

 

As I’ll explain later, there is a big difference between how the markets respond to a recession versus a bear market.

 

Looking back, on average, a US expansion lasts 58 months.  On the other hand, a recession typically lasts 11 months, on average.

 

Anybody that remembers the Great Recession knows that it actually lasted a bit longer than an average recession.  At around 18 months (December 2007 – June 2009) in duration, people rejoiced once it ended.

 

Timing the Market

Back in 2013, I got caught up in the hype.  I thought that the stock market was getting too hot.  By the summer of 2013, the stock market had continued to rise for around 4.5 years.  On average, expansions last 58 months (4.8 years) before they hit their peak.  

 

So, I thought it would be wise to stop putting new money into the stock market.  I stayed on the sideline in anticipation of the next recession.  That way I could gobble up cheap stocks when the stock market inevitably fell.

 

Guess what?

 

The market never went back into a recession.  In fact, since then, the stock market has gone up another 50%.  So much for a wise decision.  In reality, I was an idiot for thinking that I could time the market.

 

Never again.

 

Changing my Ways

While it wasn’t the best decision, not all is lost.  I was fortunate in 2016 when the market started out choppy.  I was able to deploy a ton of cash during the 10% pullback.  Still, I hope to not make the same mistake in the future.

 

After I deployed that cash, I began automating my life and investing as much money into the market at regular intervals.  That way, I wouldn’t be tempted to time the market again.

 

But What If…

What if I was able to perfectly time when a recession began and ended?  How much money could I potentially make?

 

Not nearly as much money as I thought that I would be able to.

 

Don’t believe me?  Check out this chart below.

recession

Do you notice anything with these figures?  

 

A Recession and the Stock Market

If you’re like me, you may be shocked to see that not every recession actually leads to a decline in the stock market.  Heck, during two recessions, the stock market became bull markets.

 

When most people think of recessions, they think of the Great Depression of 1929 and the Great Recession from 2007-2009, when there were massive pullbacks in the market.  

 

But, even if you incorrectly bought at the top of the market in 2007, you would have doubled your money 10 years later.

recession

As you can see, the market is much tamer than the pundits would have you believe when a recession hits.    

 

This is why I believe it’s critical to understand the difference between a bear market and a recession.  The two are not necessarily as similar as everyone thinks.  

 

So readers, did you know that the stock market is not as tied to economy as people assume?  Do you try to time the market?  Share your thoughts below.

Mustard Seed Money

Welcome to the website. A mustard seed is a very small seed but astonishingly grows very large over time. My hope is that through your financial journey that your small investment in time, money and faith will grow beyond anything that you could ever imagine.



57 Comments

  1. I totally agree that there’s no point in trying to time the market. A proper asset allocation is much more important. Keep on investing regularly, but only put money in stocks if you don’t mind a temporary 20-30 or even more percent of pull back. There will be a new recession and there will be a new bear market. The only thing is no-one can tell when. You shouldn’t worry about it either. Keep calm and invest 🙂
    Roadrunner recently posted…August 2017 Investment IdeasMy Profile

  2. I 100% totally agree – as do study after study on this topic.

    People need to remember: Even with yesterday’s 2% pullback, we’re sitting around a 12% gain YTD. If (“when” actually) the market moves into a correction cycle, we’ll still likely be well ahead over the game over recent years.

    Markets go up, and down, and then back up, etc. Holding steady with your plan through the highs and lows is the key to success.
    Brad – MaximizeYourMoney.com recently posted…How To Invest When You Know Nothing About InvestingMy Profile

      • I agree with both of you on this one. I’ve always heard that investing is for the long term so it’s best to ignore the bumps in the road. And even Warren Buffet recently said that “a well-researched investment should be worth holding onto. The intrinsic value of an investment materializes over time.” Can’t argue with the world’s best investor!
        Eliza recently posted…Do your choices reflect your priorities?My Profile

  3. I don’t try to time the market with the stocks that I am investing in anymore. However, I like to time the market for my options activity to increase my earnings.

    For example, when I own a stock that has hit the all time or 52 weeks high, I sell a cover call option with a strike price that’s even higher than the current price. If the stock hits the strike price in twelve months, I am more than happy to sell because I will be making more money.

    Another example, a few months ago, Goldman Sachs just reported their quarterly earning and they did not meet analysts’ lofty expectation. The stock dropped more than 5% in a matter of hours. I went in and sold a couple of naked put option contracts with a strike price that was 10% lower. If Goldman Sachs is above $185 next January, I get to keep the premium on the put options for free.

    I time the market to sell my options. However, I let other do the prediction, I am just fulfilling their prophecy.
    Leo T. Ly @ isaved5k.com recently posted…Everyday Personal Finance ConceptsMy Profile

    • I agree with Leo on this one. No use trying to figure out a correction, recession – although ‘trying to time’ the market is a crap shoot…. because it’s always out of the individual investors control.

      Stuff happens overnight, another cold war is on the horizon, some politician will make a stupid statement, companies miss or exceed quarters.

      For those that are buying individual securities that pay dividends that also have options, my suggestion is hedge your position, be your own ‘hedge fund manager’, pick the YOY yield that you are after…. really simple when folks do that.

      MSM, follow the ‘short futures’ VIX it really is a good indicator….wink wink

      Kudo’s to Leo for getting part of it right

  4. I’m really tired of the doom and gloom from the pundits regarding the market. Luckily I have continued investing in the companies that I believe in since the Great Recession. If you remember, even in 2011 people thought the stock market was headed for a recession.

    It seems there is a cottage industry of trying to predict the next big drop. The problem is that people aren’t very good at predicting anything (the weather, sports, political elections, bitcoin prices, etc). I agree that you need to keep dollar cost averaging in good and bad markets. It is wise to deploy extra cash when the market goes lower. That’s how you end up making big money.
    Jeff – Maximum Cents recently posted…Habits – Impact Per YearMy Profile

    • Thanks for sharing Jeff!!! I definitely agree there are a lot of people trying to call the top of the market and very few that will actually succeed. Although if they’re right, they’ll get a ton of credit 🙂

  5. Learning something new today. I didn’t know that recession was actually related to GDP! Add that to the list of things people talk about and know nothing about (Like the DOW).
    Thank you for the insight. We dollar cost average just because it is easier to work into the budget so we aren’t going to time the market. The only thing would be if the market had a big downturn we may try to throw more money in during that time.
    Budget On a Stick recently posted…Walking on SunshineMy Profile

    • Thanks for stopping by Budget on a Stick!!! I have a feeling most people dollar cost average which is nice since it gets your money into the market without having to think too much 🙂

  6. I’ve heard people predicting an incoming recession for a long time. I personally don’t want to lose my job or anyone else to suffer financially. But if there’s a recession and if Mr. FAF and I still have our jobs, we will definitely look into buying another property even if our current house is not paid off. Some opportunities are just hard to come by.
    Ms. Frugal Asian Finance recently posted…List of Asian Personal Finance Bloggers – Part 3My Profile

  7. Lol. You “timed” your article well, Mustard! The day you released the article, the S&P 500 is down almost 1.5%. Since I work for a living, I’m mostly bemused by the investing. I wake up, say “oh, my accounts lost $4k”, and go to work. I can’t freak out to much as other days I woke up and was a few K richer (especially recently).

    In the accumulation phase of my life, I agree it’s more about saving and investing instead of freaking out about the gyrations of the snake.

  8. I’ve made plenty of mistakes as an equity investor, which is why I have a bias towards real estate. If I was able to just continue shoveling money into the stock market, and not feel as emotional, I’d perhaps like equities more.

    Just got to stick it out for the looooooooong term. But with real estate, at least you can enjoy your asset while you wait.

    Sam

    • Thanks for sharing Cory!!! I do enjoy throwing my money in and not worrying about things but I get why people like having some cash available if the market tanks.

  9. Nice read, as always! Though, I dare to disagree with your assessment. The business cycle, recessions vs. expansions, is very highly correlated with the stock market. The table above misses a few very important points:
    1: the stock market “leads” the business cycle by a few months. For example, the 2009 bottom was in March the recession end in June). That explains why the equity performance is not down as sharply during recessions.
    2: The table is in nominal dollars. Sure, 1981/82 had positive returns but adjusting for inflation it had low returns (and adjusting for the 3-month lead-lag behavior the return was negative).
    3: Knowing that you’re in a recession (ideally with 3 months lead time, see #1) would have been astronomically profitable, but knowing that you’re in an expansion is profitable, too. Any market correction would reverse very quickly during a non-recession period, so it’s hugely profitable for timing a stock/bond portfolio: Buy more stocks when there’s a short correction, knowing that outside a recession the market will snap back (August 2015, February 2016, Brexit).

    Where I agree with you is this: forecasting a recession is very hard. It’s not an exact science. But if someone had the perfect formula he/she would make a boat-load of money with it!

    Also, a minor point: In the U.S., a recession is not defined as 2 consecutive quarters of negative growth (the 2001 recession didn’t have that!). The NBER has a recession timing committee comprised of leading macroeconomists. The committee calls business cycle turning points with a more sophisticated procedure, taking into account more indicators than just GDP.
    earlyretirementnow recently posted…U.S. Equity Returns: History and Big ERN’s 10-Year ForecastMy Profile

  10. The only thing I regret is not getting into the market earlier. I also wished I was able to contribute the maximum in my 401k during the so-called great recession – buy low 🙂
    I’m still glad I made my mistakes earlier and now can just sit back and STAY put in the market….hopefully. Surprising chart by the way on recessions and bull market.
    SMM recently posted…7 Popular Myths That Can Put Your Retirement Life Into DangerMy Profile

    • I definitely agree if I could do thing differently I definitely would with investing. Definitely would have made my life easier and I’d probably be further ahead 🙂

  11. MSM,
    Young investors should be in the markets for the very long haul. Over time, returns should returns to the annual mean. However, if things seem frothy or not, there’s nothing wrong with having some cash on the side. That’s not to say sell everything and cross your fingers when markets are hitting new highs. But keeping a modest percentage in cash gives you the capability to pounce on opportunities when they arise. Be they market dips, cheap real estate deals, or otherwise. When the next market decline hits, you don’t want to be 100% invested. Dry powder, opportunity fund, or whatever you want to call it.
    Retire Before Dad recently posted…The More You Own, The More It Weighs You DownMy Profile

    • I definitely agree if you have the discipline with your dry powder it can be a useful tool. Personally, I have been terrible at timing the dips the of the market so it’s not for me 🙁

  12. Agreed that timing the market is impossible and not very profitable, but I give myself a band that I’m comfortable with and may shift within it based on my (oft incorrect) perception of how frothy the market is. It’s fun and makes me feel like I’m in control, but the band is narrow enough I can’t hurt myself too much 🙂
    Paul recently posted…My Net Worth RevealedMy Profile

  13. I have been an investor for the last 2 recessions. Those past 2 have taught me what my risk/reward tolerance is. Yes, a recession is coming. When it will occur is the mystery that nobody knows.
    Dave recently posted…10 Years LaterMy Profile

    • Thanks for sharing Dave!!! I think having the experience to live through recessions is huge, especially when you see the market rise after watching your wealth evaporate.

  14. Hi,
    Good explanation of recession and yes it doesn’t necessarily mean that stock market has to always go down during a recession. Though, recessions that are caused by some type of crises, such as what we saw during 2008-09 and 2000 had big impact on the markets and tend to be deeper and wider.

    You are right that people would have doubled their money in 10 years after the last recession. However, after the last two recessions, it took 6-7 years just to get back to the pre-recession levels and not many people have the patience or ability to wait this long.

    Thanks,
    Mr. ATM

    • Thanks for stopping by Mr. ATM!!! I definitely agree that it may take a little longer for the market to come back but history has shown that it normally comes back and then goes even higher 🙂

  15. Wow I was totally guilty of thinking that a recession always led to a bear market. I agree about market timing. When I first learned about the stock market, I thought that timing when to put in money and when to pull out money was key (I had the stock “trading” mindset). After learning about passive investing though, I’m all about investing at regular intervals and generally forgetting about trying to predict when the market will do what.
    Matt @ Profitable Matters recently posted…10 Ways to Make Money Through Tech SkillsMy Profile

  16. Part of investing in equities is knowing yourself. I can be quite an emotional investor, therefore I tend to do better with relatively illiquid investments like real estate. Unfortunately I’m vulnerable to all that bubble and recession talk. If anything, I should automate all investments into the stock market at regular intervals and just not look at it ha.
    Passive Income M.D. recently posted…Journal Club 8-12-17My Profile

    • Thanks for sharing!!! I have thought about real estate but I get too emotional with that while stocks I’m not nearly as emotional about. Interesting how we differ in those areas 🙂

  17. I exhibited similar behavior in 2013 when I finally had some extra money to invest and sold early. I still kick myself sometimes because I would been richer now had I not sold and put the money in my savings account.

    I do regular contributions now, although, I haven’t done any large one-time investments yet because I am waiting for prices to dip so I can buy more shares of individual stocks. So, yes, I am still somewhat trying to time the market with additional investments.
    Josh recently posted…Why Parents Should Think Twice about Cosigning for a Student LoanMy Profile

    • Thanks for sharing Josh!!! Sounds like we’re a bit similar which is unfortunate since both of us theoretically would/could be a lot richer if we continued to invest 🙂

  18. I’ve found that the best strategy for me is to just keep investing, regardless of the situation. I guess the plan could change as I get older but I have a ways to go anyways. It’s all about the time in the market anyways for the most part. Thanks for the info!
    Mr Defined Sight recently posted…Hate Your Job? This Can Be A BenefitMy Profile

    • Time in the market is definitely one of the most important things when it comes to investing. The ups and downs of the market seem to smooth out over time 🙂

  19. Ben Stein wrote an interesting book on that back in 2003 (after the dotcom crash). His view was that you couldn’t time the market in the short term, but that certain signals/ratios allowed you to determine where the market was going over a 10-15 year cycle. Interesting reading.

    I did a review on the book a few weeks ago: http://39months.com/book-review-yes-you-can-time-the-market-by-ben-stein-and-phil-demuth/

    Mr. 39 months
    Kevin@39months.com recently posted…Book Review – Yes, You can be a Successful Income Investor by Ben Stein and Phil DeMuthMy Profile

  20. Here, here. Although, I do think that we can and should pay more attention to secular trends. In a secular bull market all things look good. In a secular bear….timing the market isn’t a good thing, but at the same time different asset classes maybe good places to put our money. That is, of course, a whole other kettle of fish.
    Jason recently posted…Best Mutual Funds for Socially Conscious InvestingMy Profile

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