Stocks beat cash even if you could time a recession

Investors could wait years for a downturn, missing out on stock market gains while their cash loses value to inflation.

The US economy is widely expected to tip into recession later this year. The Federal Reserve thinks so, as does Wall Street. And financial Twitter is aflutter with recession talk. Some financial observers are going further, advising investors to swap stocks for cash in anticipation of the looming downturn.

The problem with that advice is that no one knows if or when a recession will materialise. Investors could wait years for a downturn, missing out on stock market gains while their cash loses value to inflation. Or worse, they could dip in and out of stocks as recession predictions come and go, losing money to ill-timed trades along the way. Indeed, there are numerous ways a strategy built on unreliable forecasts can — and probably will— go wrong.

But let’s say you’re blessed with magical powers to spot recessions. Before dumping stocks and moving to cash, it would be worth knowing how such a maneuver would have performed in the months leading up to previous downturns.

According to the National Bureau of Economic Research, there have been 30 recessions since 1871, the longest period for which performance data is available for the S&P 500 Index and its predecessor compilation of US stocks. I looked at how the S&P 500 performed six months before each of those recessions and found that it produced a positive total return 21 times. So even if you knew a recession was coming, you would still most likely be better off in stocks in the months leading up to it.

What if your foresight was so formidable that you were able to predict both the start and end of recessions? If you sold your stocks six months before each of the previous 30 recessions and stayed out of the market until the recession ended, you would still have had only an even chance of outsmarting the market. Stocks produced a positive total return 15 times.

Of course, with such powers you could dump stocks on the eve of recessions and stay out for the duration. The odds would flip in your favor, but it still wouldn’t be a slam dunk. The market managed to produce a positive total return during 12 of those 30 recessions.

The stock market is also forward-looking and multivariate. Numerous factors drive stock prices, including those specific to each industry and individual companies, and for many multinationals in the S&P 500, the outlook beyond US borders. Stock prices also tend to digest these considerations well before they are expected to occur. The S&P 500 may have absorbed recession fears last year when it declined nearly 20 percent. And its turnaround so far this year may signal that it's already looking past a possible recession.

All of that makes investing based on economic forecasts incredibly tricky. No surprise that, as the historical record shows, even if you could predict the extent and timing of economic outcomes with precision, you still wouldn’t necessarily know how or when the market would react.

The good news for mere mortals is that none of that maneuvering around the market is necessary. The best result is likely to be achieved by hanging on to stocks and ignoring the economy. During the periods beginning six months before and ending six months after each of the previous 30 recessions, the market produced a positive total return 22 times. Investors were also amply rewarded for their patience with a median total return of 16 percent, by far the highest median return of the four scenarios I looked at. And things improved from there as recessions gave way to new booms.

As recession talk intensifies in the coming months, and with it calls to sell stocks, those endowed with superpowers of economic forecasting are free to try their hand at outsmarting the market. Everyone else should probably sit tight.

Nir Kaissar is a Bloomberg Opinion columnist covering markets. He is the founder of Unison Advisors, an asset management firm. Views are personal, and do not represent the stand of this publication.

Credit: Bloomberg