Chart of the Week: The Better Recession Question

Jeffrey DeMaso

Portfolio Manager

The economy—measured by real GDP—contracted in both the first and second quarters this year. So, are we in a recession or not?

We say: Who cares? The question investors should be asking is “What do we do with the information?”

To help answer this question, I identified past periods when GDP went negative in consecutive quarters and looked at how stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. (measured by the price return of the S&P 500 index) performed over the following 12 months.

Generally, stocks performed pretty darned well. The average return in the year following back-to-back quarters of economic contraction was 23.3%. That’s nearly three times stocks’ average 8.7% return in all 12-month periods.

So, if there’s one thing you should be doing if you’ve got cash, it’s buying. And if you don’t have cash, then the one thing you shouldn’t be doing is selling.

If you’re worried about the economy continuing to slide from here, look at the Great Recession. The economy contracted in the third and fourth quarters of 2008. Had you bought stocks at the end of 2008, you would’ve earned a 23.5% return over the next 12 months—despite the fact that the economy continued to contract well into 2009.

Of course, buying after a two-quarter economic decline is no guarantee. The economy contracted in 1980 and stocks declined about 7.5% in the following year. But on average, buying after a couple of negative GDP reports has been a profitable strategy.