What does an economic slowdown mean for the market?
In my last post, I wrote about the positive impact of financial planning on an investor's ability to stay in the market and manage the cognitive bias of loss aversion. In this post, I want to address recessions, market performance, and the cognitive bias of "recency." Recency bias occurs when an individual is more inclined to remember something that happened more recently than what may be recognized years before, creating a bias.
Economic Slowdowns and the Market
Several times in the last few days I have heard a stock market prognosticator suggest an economic slowdown is upon us. So, what is a slowdown or “recession”? Technically speaking, a recession is two consecutive negative quarters of GDP growth. Importantly, recessions are not uncommon and do not necessarily coincide with a decrease in the stock market.
While examining the chart below, the first column highlights the last nine recessions. The next five columns track the corresponding stock market performance for one year before the recession, the stock market return for the length of the recession, along with one, three, and five-year performance following the recession. In my view, the data is quite interesting and full of surprises.
Recency bias, as mentioned above, clouds an investor’s understanding of complete market data. As such, with the last two most recent recessions having had a negative 35.5% and 7.2% respectively, investors are more likely to believe all recessions have comparably negative returns—this is in fact not true.
Although recessions and market volatility are unnerving, it is both normal and part of the price we pay for the opportunity to achieve fantastic long-term returns. We encourage you to focus on the financial plan which offers investors the best odds of achieving financial success.