It’s possible that we’re headed for a recession in the United States right now.
However, that may not mean what you expect it to mean — especially for your investments in the stock market.
Here’s what a recession is by definition, how the stock market historically reacts to recessions and what money expert Clark Howard says about how you should invest before and during a recession.
Table of Contents
- What Is a Recession?
- What Happens to the Stock Market Before, During and After Recessions?
- Is a Recession Coming?
- Should a Recession Affect Your Investing Strategy?
What Is a Recession?
Most of us probably think of a recession as a general period of overall poor performance by the economy, including the stock market.
But do you know the current definition of a recession, and who (or what) declares one?
In 1974, Julius Shiskin, then Commissioner of the U.S. Bureau of Labor Statistics, created the textbook definition of a recession. It included precise, data-based metrics.
But the National Bureau of Economic Research (NBER) now declares when recessions start and stop.
The private nonprofit research organization defines “recession” a little more loosely: “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales.”
One reason for the change is that a recession is blind to the scheduled releases of the latest GDP data. The NBER doesn’t want to wait for the next GDP number to get printed to declare a recession, so it looks at several different data points.
Note that some major characteristics of a recession include higher unemployment and lower retail sales. However, stock market prices are not tied to the definition of a recession.
A struggling economy may or may not correlate with a struggling stock market, as I’ll discuss in the next section.
What Happens to the Stock Market Before, During and After Recessions?
You might imagine that as soon as you see the word “recession” in a headline from your favorite news organization, it’s time to brace for pain in the stock market.
However, that’s not especially true. Darrow Wealth Management, an asset management and financial planning firm, recently studied data from the last 11 recessions in the United States, dating back to 1953.
Per the chart above, here’s an interesting look at stock market performance the year before, during, and the year after a recession:
|12 Months Prior||During Recession||12 Months After|
According to Darrow’s data, in the last 69 years, stocks performed worse the year before a recession than they did during the recession itself. The average recession lasted 10.3 months. And stocks shot up 16% in the year after the recession ended, on average. The S&P 500 improved at least 8% in 10 of the 11 cases.
“The economy is going to slow and we might go into a recession, but that’s all that’s going to happen,” money expert Clark Howard predicts. “There is no Armageddon coming.”
Is a Recession Coming?
Recessions are exceedingly difficult to predict. However, many Wall Street firms and economists are forecasting that the United States will enter a recession at some point in the next six to 12 months.
Unemployment tends to be a lagging indicator of a recession, as it shows up once a recession is already here. One month before COVID-19 hit, in February 2020, unemployment got down to 3.5%. That was the lowest level in the United States since May 1969.
Unemployment spiked to 14.7% in April 2020 before rapidly improving to just 3.6% in March 2022, the last available data point.
There are, however, some leading indicators that sometimes predict recessions. Those can include:
- An inverted Treasury yield curve
- A decline in consumer confidence
- Large or sudden stock market declines
Our Current State: Is a Recession Coming?
The yield curve phenomenon is complex. But currently, the one-year Treasury yield is 2.1% compared to a 10-year Treasury yield of 2.9%.
In other words, we’re currently experiencing an inverted Treasury yield curve, which is often the biggest indicator that a recession is on the horizon.
Clark has talked consistently about some major driving factors in our current economy.
That includes supply chain issues, extra money circulating in the economy, inflation (including high oil prices), excessive debt (personal or with some big businesses), a hawkish Federal Reserve and Russia’s war in Ukraine.
To reinforce an earlier point, it’s difficult to predict if and when we’ll experience a recession. But Clark has some clear thoughts on how it should or shouldn’t impact your investing strategy.
Should a Recession Affect Your Investing Strategy?
It seems clear that even the threat of a recession can spook certain people from investing in the stock market.
Clark has received and answered several questions about this on his podcast in recent months. The listeners want to know if they should stop investing — or even if they should sell off their investments.
“Markets, even after a painful decline, eventually recover,” Clark says. “The younger you are, the more a decline in the market ultimately makes you money down the road, because you’re buying everything on sale for what, over your working lifetime, will probably recover many times over.
“As long as your money is diversified in a way that’s appropriate to your age, just ignore the headlines and hang in there.”
If you’re still far from retirement, halting your investments during a market downturn is precisely the wrong strategy. Not only are you getting a discounted price on stocks, but you’re likely to miss out on the next round of big gains.
Take a look at how Darrow’s data show the market performed during these negative events and in the 12 months after:
|Event||Market Decline||12 Months After|
Don’t Allow a Recession To Change Your Long-Term Investing Strategy
As of this writing, the S&P 500 is down 13.3% and the NASDAQ is down 21.2% this year. Some economists are theorizing that barring a major catalyst, most of the market declines are now priced in — or will be priced in within the next three to six months.
If you’re a long-term investor working toward retirement, it’s almost always best to ride out market declines.
Even if you time the top of the market correctly, you may get stuck with a large tax bill for realizing gains. And it can be even more difficult to time the end of the decline. That’s often the precise time when the stock market experiences its biggest gains.
It’s difficult to predict whether a recession is coming. There are some smart economists (and data) that suggests we may be headed for a recession in the United States.
However, that doesn’t mean that we’re in for some type of Armageddon in the stock market, as Clark pointed out. In fact, if you’ve been following an age-appropriate investing strategy, you shouldn’t change anything at all.
Most recessions in the United States are pretty short-lived, typically lasting less than one year. And the economy almost always improves in a significant way in the year or two after a recession.
In other words, recessions happen periodically and shouldn’t be as scary as the headlines make them seem.
Do you think we’re heading into a recession? Share your opinion in our Clark.com community.