Because the criteria for a recession have most likely now been satisfied, it’s time to buy stocks. I doubt that is your first (or second, or third…) reaction to news that U.S. GDP contracted in the first quarter and most likely in the second quarter —thereby satisfying the traditional definition of a recession as two consecutive quarters of economic contraction.
According to something known as the “Recession Buy Indicator,” a good time to buy stocks is when it first becomes obvious that the U.S. economy has been in a recession. That realization typically occurs around the seventh month of the downturn, given the traditional definition of a recession and the time lag for economic data to be gathered and reported.
Since the median U.S. recession lasts around 14 months, and given that the stock market discounts its future value six- to nine months in advance, stocks not infrequently are bottoming around the same time that the news headlines are heralding that the economy is in a recession.
It’s important to acknowledge that it’s not guaranteed that a recession began in January. But in recent weeks, more Wall Street analysts have confidently stated that the U.S. is in a recession. This steady drumbeat of recession declarations may be having just as big an impact on the market as a declaration from the National Bureau of Economic Research, the semi-official arbiter of when recessions begin and end. Don’t expect such an official proclamation any time soon, since the NBER typically reports those beginnings and endings with a substantial time lag.
The Recession Buy Indicator was created by Norman Fosback, who for a number of years beginning in the 1970s was president of the Institute for Econometric Research. In the May 8, 2008, issue of his newsletter Fosback’s Fund Forecaster, which is no longer published, Fosback reported that the Recession Buy Indicator (RBI) had an “incredibly accurate” record.
Though Fosback was writing 14 years ago, his comments are eerily relevant to today: “Public opinion polls show a populace flagging in confidence at virtually every level, … expecting the worst for their future financial well being.” But, he continued, “the stock market, to its timeless credit, has little use for yesterday’s, or even today’s, crises. The focus is always on the future.”
To measure the performance of the Recession Buy Indicator (RBI), I focused on all NBER recessions since 1870 — a total of 30. I went back that far because that’s when monthly stock market returns are available on Yale University professor Robert Shiller’s website. Because I had no way of knowing when investors actually would have been able to know when each past recession had indeed started, I assumed that the RBI was triggered seven months after when the NBER says the recession began. The accompanying chart shows the S&P 500’s SPX, +0.13% average inflation-adjusted total return over the 3-, 6- and 12-month periods following those triggers.
In all cases, the stock market’s return following RBI signals was above average. To those who might object that the long-ago data aren’t as relevant, I note that the RBI’s record would be even more impressive with a focus on only more recent decades.
To be sure, the RBI is not foolproof. By definition, the indicator will be premature when recessions are much longer than average. During the Global Financial Crisis, for instance, the RBI was triggered in mid-2008, nine months before the stock market actually bottomed.
Overall, though, the RBI has been right more often than not. The broader implication of its success is that the time to buy is when the news is all, or even mostly, all bad. If you wait until the news is good, you will miss out on much of the stock market’s subsequent recovery. As Fosback wrote in 2008: “If it’s a recession… Buy!”
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org