As we have navigated the last two years of recovery from the global pandemic, we have often heard calls that we are on the cusp of a “recession” or in a recession already. The mere sound of this word can elicit feelings of dread and uncertainty. So far, the reported unemployment rates remain low even as reported labor force participation has continued to rebound toward pre-pandemic levels.
Both stock and bond markets have been strongly positive in the first half of 2023. This is significant in the face of all the challenges we have seen since the beginning of last year.
Since then, we have had inflation touch 9% and a war in Ukraine. The Federal Reserve has increased interest rates by 5%, creating a slowdown in lending activity in the economy, and we have seen a banking crisis with the failure of three midsize banks (Signature Bank, First Republic Bank and Silicon Valley Bank). In the face of all of this, it would be natural to expect a substantial recession to have already hit, but that expectation has been wrong so far. The U.S. economy has been resilient through all the shocks and continues to chug along.
This is not to say things are perfect … far from it. Inflation has been showing signs of moderating but is still with us, and real GDP growth (net of inflation) remains positive yet weak. It is possible that we could end up in a more significant downturn before long, and eventually, there will be a “significant recession” sometime in the unknown future.
So far, the volume of discourse around an economic downturn over the past two years has likely been overstated. What can we learn from this? There are two key takeaways:
The economy is an incredibly complex beast, intertwined with numerous factors, including consumer behavior, governmental policies, global events, and technological advances. Predicting its future movement with precision is like accurately forecasting every NFL team’s win-loss record next year.
Some economic signs, such as inverted yield curves, increasing unemployment rates or reduced industrial production have historically been associated with recessions. But they are far from perfect predictors. There have been many instances where these indicators have signaled a downturn, but no recession occurred.
The difficulty with predicting the performance of the global economy lies in its complex and dynamic nature, which is affected by both quantifiable factors and human behaviors that are challenging to measure and accurately forecast. Predicting downturns is not only about the analysis of data and trends but also about understanding a multitude of human decisions and global events. This inherent unpredictability makes the precise timing of downturns an elusive prospect.
Pessimism often seems intelligent, especially when it comes to investing. After all, the pessimist is seen as the vigilant, cautious individual who saves us from our worst impulses. They caution against taking excessive risks and remind us of the brutal economic downturns we have faced in the past.
However, while pessimism might sound smart and sophisticated, it does not necessarily lead to the best outcomes in long-term investing. History has shown us that the stock market, despite its ups and downs, has trended upward over the long term. The patient investor, who stays the course during economic downturns, usually reaps the rewards. Patience rewarded. Investing is an act of optimism and a belief in human ingenuity’s ability to create value over the long term.
Being optimistic does not mean turning a blind eye to risks. It is about having a positive long-term outlook while acknowledging short-term hurdles. Optimism is not about expecting the best to happen every time but accepting that over time, societies progress, economies grow, and, as a result, companies will increase in value.
Combine this optimism with discipline — an essential trait for any successful investor — and you have a potent mix. Discipline means developing a robust, well-researched investment process and sticking to it, regardless of market volatility. It involves regularly investing, diversifying your portfolio, and resisting the urge to react to short-term market fluctuations.
Consider this: The Dimensional Global Core Equity Index has not had a negative 10-year period since its inception in 1975. If you had invested at the beginning of any 10-year period dating back to 1975, you would not have lost your investment at the end of the period, despite numerous recessions within those periods. This historical perspective underscores why long-term optimism, when combined with discipline, is an effective approach to investing.
In essence, while pessimism may seem prudent, and even intelligent, in the face of potential economic downturns, an optimistic outlook coupled with a disciplined investment strategy generally yields better long-term results. So, as you monitor the economic landscape and consider the possibility of a recession, remember not to let short-term pessimism derail your long-term financial goals.