A few have asked this. Others have likely thought it. We disagree with both assumption and conclusion.
Recession (generally, two consecutive quarters of declining real economic growth) may occur but is far from assured. We never know when recessions begin or end until well after the fact because of reporting lags. Even then, the data are often revised significantly for some time. Some have recently asserted that a US recession has already begun, while other highly regarded “experts” predict a slowdown but no recession.
Those arguing that a recession is imminent cite the unwinding of the residential real estate bubble and the associated credit crunch which initially hit subprime mortgages, but spread to nearly every kind of fixed income instrument with credit risk (and the financial institutions that hold them). But there are reasons for optimism too: strong exports (because of strong overseas economies and a weak dollar) and aggressive interest rate reductions by the Federal Reserve.
Recessions are associated with stock market declines. In the last 55 years, there have been nine recessions, and each has had an associated stock market drop, averaging 25.6%. In a third of those, the stock market only declined between 13% and 15%. Two others saw declines of about 20%. The other four saw larger stock declines of between 27% and 48%.
But the stock market is a leading indicator! Of these stock declines, the largest parts occurred in the months before the recessions began, with very little occurring during the recession itself. The average recession (since WWII) has lasted about 10 months, and on average, the stock market was actually flat during the recession itself (and rose in three of the last four). Breaking that down further, stocks declined by about 5% on average in the first five or six months of recessions, and they’ve risen by a similar amount in the remaining months. Stocks have tended to turn up several months before recessions have ended, and from that point, averaged 24% in gains over the next six months.
The S&P 500 index has already experienced a decline of 18.9% (from 1565 on October 9th to its low of 1270 on January 23rd). That decline already exceeds those associated with three of the last nine recessions and is nearly equal with two more (and many stocks, especially in banking and retailing, are down 50% or more). If a recession is here or coming soon, the stock market adjustment may have already occurred.
Market declines produce improved valuations, which in turn imply both lower prospective risk and higher prospective returns from that point on. One gauge of stock market valuation is “the Fed Model” (so named because the Federal Reserve first published it). It compares the stock market’s P/E ratio to Treasury yields, and by that measure the S&P 500 recently looked more undervalued than at any other time in the past 30 years. This is an imperfect tool at best - even if current extreme readings prove useful in the long run, valuations could certainly get more extreme before they get better. We mention this only to point out that by some measures, stocks already look cheap.
In the face of a potential economic slowdown of uncertain magnitude with aggressive Fed response and significantly lower interest rates, stocks have fallen enough already to make selling at this point a risky proposition.
Beyond that, choosing to sell some stock positions with the intent of buying back later is much more problematic than simply getting the timing of the sale right. There is also the problem of getting the timing right on the subsequent stock purchases, which can be even more difficult than the sale because of the rapid up-moves markets typically make off market bottoms. For taxable accounts, capital gains taxes are a significant cost to such an approach. And, importantly, there is also the question of what to buy with the proceeds. Generally, bonds or money funds are thought of as the alternative, but today the 10-year Treasury note yields a little over 3.5%, which is hardly compelling.
Avoiding market timing is a key tenet of our approach because history has demonstrated that investors who attempt to sidestep bear markets by trying to sell at tops and buy back at bottoms usually lose. Investors would generally be much better off if they could just set an asset allocation mix and then periodically rebalance to stick with it, as we do. But having the discipline to do that is not easy. What is easy (and tempting) is to believe some advantage could be gained by selling some stocks when the media shrilly proclaims doom. That’s a bad idea generally, and it looks like an especially bad idea right now.