According to Investopedia, a recession is a period of economic downturn lasting more than a few months that is reflected in a decline in several economic markers: gross domestic product, employment, manufacturing, and retail sales.
While recessions have a definite negative impact on the overall economy, they also tend to reverse the way that different asset classes perform in comparison to each other. This is neither good nor bad, but it does make the case for the importance of maintaining a well-diversified portfolio.
Let’s review how four different pairs of asset classes have historically reacted to the two U.S. recessions that have occurred in the last 20 years: the so-called bursting of the tech bubble (2000-2001) and the Great Recession (2007-2009).
1. U.S. stocks versus non-U.S. stocks
Before the tech bubble burst, U.S. stocks were outperforming their foreign counterparts. After the bubble burst, international stocks took over, growing by an astounding 115% between November 2001 and October 2006.
However, in the aftermath of the Global Financial Crisis (which led to the Great Recession), U.S. stocks reclaimed the lead from international stocks.
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2. U.S. large-cap stocks versus U.S. small-cap stocks
Large-cap stocks were ahead of small-cap stocks until the recession; following the collapse of the tech bubble, small-cap stocks overtook them. Small caps advanced by more than 90% between November 2001 and October 2006.
When the Great Recession struck, small caps continued to outperform large caps over a five-year period. However, in the three or so years leading up to this downturn, large-cap stocks led small-cap stocks. This makes sense when you consider that large companies tend to be more stable than smaller companies during times of economic duress.
3. U.S. growth stocks versus U.S. value stocks
Leading up to the 2000-2001 recession, U.S. growth stocks led while U.S. value stocks lagged. Following the downturn, value gained over 56% in the five years between November 2001 and October 2006.
Then came the Great Recession, when growth stocks came roaring back, gaining over 141% between June 2009 and May 2014.
4. Inflation-sensitive assets (such as commodities, real estate and energy stocks) versus U.S. Treasury securities
Historically, these two asset classes have tended to compete as market leaders. Prior to the Tech Bubble bursting, inflation-sensitive assets lagged Treasurys, but overtook them in 2001.
The performance of these assets during the Great Recession was mixed. However, Treasurys once again led inflation-sensitive assets going into the downturn; yet ended it trailing real estate and energy stocks.
No one can possibly predict what the next five years will bring. But, if we go by the recent history of asset-class leadership leading up to and following recessionary periods, we know that things will likely be different than the last five years.
What are the takeaways from this history lesson?
One: recessions change market leadership.
Two: unless you have a reliable crystal ball, there’s no way to know what the future has in store. And three: market conditions will probably be different than they were in the last five years.
This is yet another reason to make sure that your portfolio isn’t just diversified across U.S. companies, but also across sectors, asset classes and companies around the world.
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