Anatomy of a Recession: Mid-Cycle Transition No Reason to Sell

While many economic indicators continue to show strength, the current environment likely represents economic and earnings growth as discussed previously. Although some market participants appear to be worried about an impending slowdown, we continue to believe the economy is undergoing a somewhat typical handoff from the early- to mid-cycle. This period often is accompanied by choppier equity markets as investors seek to ascertain the dominant themes of the next expansion. Even though these can only be known with the benefit of hindsight, a double-dip recession is clearly not on the horizon.

Modern Expansions Have Had Staying Power

Double-dip recessions – a second recession occurring within a year from the end of the prior one – are rare with just one example since World War II and three since the mid-1800s, according to the NBER. In recent decades, the economic expansions have lengthened with recessions occurring less frequently. The last four expansions, for example, have lasted 103 months on average (slightly over 8.5 years). In fact, three of the four longest (and four of the six longest) expansions in history have played out over the past four decades.

A similar pattern is evident when looking at the ClearBridge Recession Risk Dashboard, with 82 months on average (excluding the 1980 double-dip) between when the dashboard recovered to overall green levels following a recession and the start of the subsequent recovery. Further, a shift toward longer green periods relative to history has occurred in tandem with the elongated economic cycles of recent years. Perhaps more importantly, equity returns during these historical periods have averaged 7.5% on an annualized basis during the period between green and the next recession, and an even stronger 10.6% between green and the market peak that occurred prior to the recession.

Exhibit 2: Equity Returns Robust During Expansionary Dashboard Periods

Annual returns are of the S&P 500 Index from the first post-recession green signal on the ClearBridge Recession Risk Dashboard to the next recession and from the first post-recession green signal to the S&P 500 peak. Source: National Bureau of Economic Research, Bloomberg, ClearBridge Investments.

While returns have historically been solid during economic expansions, markets have not been immune from volatility. There are meaningful corrections during any economic cycle. For example, the last bull market cycle witnessed three near-bear market corrections of 15-20% (2010, 2011, and 2018), two drawdowns between 10-15% (2016, 2018), and three additional pullbacks within 30 basis points of 10% (2011, 2012, 2015). Although some newer equity investors may shudder at the thought of enduring that type of choppiness again, these flushing out periods are healthy and an essential foundation for a fledgling bull market.

Given heightened volatility during the last three transitions from early-to mid-cycle in 1994, 2003, and 2011, a period of consolidation ahead would not be surprising. In retrospect, each of these periods proved great buying opportunities for long-term investors. Given today’s robust economic backdrop, built on the strength of healthy consumer and business balance sheets, we feel any correction would witness a similar outcome.