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Economic Foresight and Investment Decisions

By admitting to yourself that you have no special advantage, you give yourself an enormous advantage.

-Tony Robbins

One of the biggest worries for investors is the state of the economy.  Changes in employment rates amid the pace of economic activity and in a myriad of other important conditions can move the needle on the business climate and on interest rates.  Could these changes also lead to ups and downs in the stock market?

Stock prices are considered a leading indicator of the economy.  This means that they’re likely to fall in anticipation of an economic downturn — or recession, as investors look to reduce risk in economic uncertainty.  It also means they’re likely to rise if investors are forecasting a smooth, upward trajectory for the economy.

Economic Foresight and your Investment Decisions

Let’s explore whether having perfect foreknowledge about the economy helps investors to avoid losses in the stock market — an example of the “special advantage” that Tony Robbins cites in his quote.  The chart below plots every recession in the U.S. economy since 1950 as defined by the National Bureau of Economic Research.  If you knew with absolute certainty that a recession would begin in one year, would you consider buying more stocks or selling the ones you already own?  The blue bars measure that strategy — for example, for the most recent recession which started in Dec 2007, an investor who held stocks starting in Dec 2006 to Dec 2007 earned about a 7% return.  Stocks rose rather than falling on the 12 months leading up to that recession.

So, having that special advantage of knowing about the economy well ahead of time didn’t pay off in that instance, and has had a scattered result based on the nine recessions below.  The fact is, stocks don’t perform consistently in the one year before a recession. If that’s not a good gauge, would it help if we had the special knowledge of exactly when recessions start and end and are able to use that knowledge to avoid stocks during the economic downturn instead?

The outcome to this strategy is measured in the orange bars.  For example, the most recent recession started in Dec 2007 and ended in June 2009.  An investor who didn’t hold stocks over this period avoided a 35% loss, but what about the rest of the time?  Most recessionary periods didn’t result in big losses for investors and in fact more had positive returns for stocks than negative ones.

Controlling Your Time Horizon

So, the special advantage of having perfect knowledge about the economy hasn’t actually paid dividends.  How about an ordinary ability that can give investors an enormous advantage instead?  The ordinary ability all investors have is the power to control their time horizons.  When you commit to buying stocks, are you prepared to hold them for the long term – say, at least five years?  The gray bars plot the returns to that long-term commitment and they average an impressive 56% return for an investor who was willing, even with the bad-timing of getting started right in the first month of each of the past nine recessions, to hold stocks for the next five years.  That’s an annualized rate of return of just over 10%.

The Value of the Long-Term Horizon

Economics is an incredibly important discipline.  It informs decisions about interest rates and business activity.  The state of the economy and potential changes to it often get called into decisions about portfolios, too.  Stock prices march to so many different drum beats that the state of the economy has not moved them in consistent directions in the short term.  However, in the long term the results for stocks have been robust, even for investors that started investing during recessions.  The bottom line: when investors give themselves the advantage of having a long time horizon, they give themselves a much more powerful edge over anyone else who is trying to predict the economy.

Additional Important Disclosure Information

The index returns shown above show the total return for various investment indices and include the impact of the reinvestment of dividends. A comparison to indices may not be a meaningful comparison. Comparisons to benchmarks have limitations because benchmarks have volatility and other material characteristics that may differ from the performance of a client’s portfolio. The investments in a client’s portfolio may differ substantially from the securities that comprise each index and are not intended to track the returns of any index. One cannot invest directly in an index, nor is any index representative of any client’s portfolio.  Actual client accounts will hold different securities than the ones included in each index. The index returns are gross of applicable account transaction, custodial, and investment management fees. The actual investment results would be reduced by such fees and any other expenses incurred as an investor.  Please below for definitions of the indexes used.

S&P 500 Index – The S&P 500 is an index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Each constituent in an index is weighted by its market-capitalization, as determined by multiplying its price by the number of shares outstanding after float adjustment. The price return of an index is a measure of the cap-weighted price movement of each constituent within the index.

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.

This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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