Like all parents, I lie to my kids sometimes.
The biggest lie I tell them is they can be anything when they grow up — even the president of the United States. But I know they don’t have what it takes to be any kind of politician, let alone the president.
First off, they know right from wrong. That alone disqualifies them. They also don’t just make things up. Their child-brain imagination is more grounded in reality than a politician’s.
Jokes aside, my point is politicians are all too happy to lie if it means reaching their only goal, which is getting elected.
And lately, they’ve been telling one seriously dangerous lie: We’re not in a recession.
Here’s the issue with that…
The Dallas Fed admitted that “the nation’s GDP fell 1.6% on an annualized basis in first-quarter 2022 and was followed by a 0.9% drop in the second quarter.”
In 2019, a member of the White House Council of Economic Advisers wrote that a recession “…is typically defined as two consecutive quarters of declining growth.”
Okay… That’s exactly what we’ve just experienced. So, we’re in a recession?
But no, that same economist just said: “It is very hard to conclude we are in a recession when you look at the payroll and the job gains that we’ve seen.” President Biden agrees, insisting it’s too hard to tell if we are in a recession now. Though, he admits we may see a “slight recession” soon.
As much as politicians want it to be, a recession isn’t a matter of political debate. It has massive negative impacts for everyone enduring it. Ignoring the reality won’t help anyone.
The sooner we as traders accept we’re in a recession, the sooner we’ll understand that this bear market isn’t going away anytime soon. Even more importantly, it’ll help us see that this bear market is likely to be much worse than most investors are ready for.
Bears With Recessions — the Perfect Storm
As we face a bear market, analysts are quick to point out that recessions are common. On average, they occur about every 3.6 years. The S&P 500 loses an average of 36% in a bear market. That’s about a third of the bull market’s gain.
Based on that, it sounds like if you just hold on through the bear market, you’ll be okay. Experts say that’s easy to do since bears last less than 10 months on average. That’s less than a third as long as bull markets.
As always, the experts are sharing only part of the story. All that applies to an “average” bear — which can happen even outside a recession. But bears associated WITH recessions are much worse than average.
I count 15 recession/bear market combos since 1928 — and 10 of them lost much more than average. The worst was a loss of almost 62% in the Great Depression.
On average, these recession bears lasted 10 months. But that’s just the first wave. After those 10 months, we often saw a short bull market that then led into a second bearish wave.
That 62% loss in the Great Depression was part of a longer-term downtrend that eventually pushed the S&P 500 down 87%.
This is all important to know, because even if we believe the politicians that say we aren’t in a recession yet, we are certainly heading into one.
That viewpoint puts me in good company. JPMorgan Chase CEO Jamie Dimon said he expects both the U.S. and the global economy to fall into recession by the middle of next year. That makes it even more critical to understand the 1931 bear market.
In the Great Depression, we had five rallies of at least 20%. You can see each of these in the chart below:
(Click here to view larger image.)
This is telling us that the current burst of enthusiasm for stocks is likely to be short-lived. The second leg down is likely to be worse than the first, and that’s what I’m convinced lies ahead of us.
I don’t know how deep this bear market will be. But I’m not teaching my kids to simply hang on and that everything will be okay.
I’m teaching them to see what’s in front of them and react appropriately. No use in pretending things are better than they are.
When they’re a little older, I’ll teach them how to trade a bear market. Because I know they’ll see many of them in their lifetime.
For now, my advice to you is to continue leaning bearish as we get closer to an “official” recession. Don’t deploy all your liquid capital at once here, and certainly don’t chase any rallies. Prepare for a worse bear market than you expect, and you’ll be well ahead of most other investors.
Amber Hestla Senior Analyst, True Options Masters