A whiff of recession

The current market narrative could be summed up as follows: inflation is proving more persistent than expected, central banks (particularly the Federal Reserve) will have to raise interest rates more and faster than projected a few months ago, and this would hurt economic activity, inducing a recession. Thus, the U.S. stock market has entered a “bear market” (that is, a decline of more than 20% from its highs) and investors are seeking safe-haven assets.

The initial intuition is to lower the risk level of portfolios; however, when we review the numbers we find some nuances.

First, the probability of recession—according to professional forecasts compiled by the Fed—currently stands at 20%, not so far from its baseline level: 17%.

In addition, when examining U.S. stock-market returns from World War II to date during recessionary periods, although there is heterogeneity across events, we see that in the 6 months before an economic contraction the market—on average—rises 1.1%. During the recessionary period it has averaged a return of 1.4%, and in the 1, 3, 5 and 10 years following a recession, average returns above 14% per year are observed, well above long-term figures.

Although we can't rule it out, no one can predict with certainty whether we are facing the next recession. However, the evidence shows that for the long-term investor, maintaining discipline and a diversified portfolio aligned with their risk profile is the best way to face these phenomena.

This column was originally published in the newspaper La Segunda on June 23, 2022 [LINK]