Coronavirus fears have hit the stock market hard, and they’re also having a dramatic impact on the U.S. economy. The airline and cruise ship industries have already come to a near-standstill as would-be travelers wait to see if travel restrictions come to the U.S., and the outbreak likely played a role in the dispute between Russia and Saudi Arabia that led to the collapse in oil prices earlier this week. With the federal government now looking at potential fiscal stimulus measures, concern about a possible recession has reached a fever pitch.
Investors haven’t dealt with an outbreak like COVID-19 before, but there have been plenty of past recessions. History has some important lessons for investors who’ve never gone through a recession before, and even experienced investors can benefit from reminders about how past economic contractions have gone.
1. You never know you’re in a recession until it’s already started
Many economists set the official definition of a recession as two straight quarters of falling gross domestic product. That length of time is somewhat arbitrary, but what it means is that it takes a long time to confirm that a recession has actually started. For instance, it wasn’t until January 2009 that official confirmation came that U.S. GDP had fallen two quarters in a row. By then, much of the damage was done. Indeed, in the tech bust of 2000 to 2002, there were never two consecutive quarters of falling GDP — merely a dramatic slowdown in the pace of growth with a couple of isolated quarters of GDP declines.
Even if the coronavirus causes GDP to fall in the current quarter, it’d take another drop in the second quarter of 2020 to bring an official recession. The first read on second-quarter GDP numbers won’t come out until late July. Investors therefore need to prepare for a lot of speculation in the coming months about whether we’re actually in a recession. Even with some painfully obvious indications that economic activity is falling, that debate will continue until official confirmation comes.
2. You never know you’re out of recession until it’s already ended
Similarly, it takes time to confirm that a recession has officially ended. In 2009, the economy started growing again in the third quarter, but by the time that data became available in October, the stock market had already bounced back dramatically. Similarly, the recession that coincided with the first Gulf War in 1990 ended by mid-1991, but investors who waited for official confirmation missed out on considerable gains in the stock market.
3. Financial stability becomes paramount in recessions
The biggest problem during recessions is people seeing disruptions that affect their normal sources of income. For most people, that involves losing their job or facing work cutbacks. If you’ve been living paycheck to paycheck with extensive debt, even small reductions to income can be problematic, and getting laid off entirely can be catastrophic.
Keeping unnecessary debt to a minimum and building up emergency savings is the best way to prepare for a possible recession. With the recent drop in interest rates, actions like refinancing a mortgage can also cut your monthly expenses and put you in a better position to weather a financial storm.
4. Recoveries come — eventually
Recessions seem to last forever, but historically, they’ve been relatively short and have gotten shorter over time. When you look at recessions after World War II, the average length is less than a year. Even when you look further back at history, recessions typically lasted less than two years.
Moreover, the good news for investors is that stock market performance is well above average in the periods following recessions. When you look at historical return numbers one, three, and five years following the end of recessions, rebounds have often been steep and impressive.
Those who survived the Great Recession of 2008 and 2009 are justifiably concerned about the prospects of having to go through another contraction in the U.S. economy. Yet history shows that even though it’s painful when a recession is happening, the economy has always bounced back — and brought good news for long-term investors who stayed the course.
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