Lately, I have heard the phrase “long in the tooth” to express concern about the extended duration of our current economic expansion, almost ten years now. The fear is that we are somehow overdue for a recession, without any more specific rationale than that the current expansion has been a longer one than usual. My immediate, lighthearted response has been “don’t jinx it,” as this fear may be based more on superstition than on fact. However, a more thoughtful response would have considered the origin of the phrase “long in the tooth.” The phrase has origins in horse-trading, where the apparent length of a horse’s teeth is a considered a good measure of the age of the horse (or at least the extent its receding gum line!). Had I remembered that, I might have responded, “don’t look a gift horse in the mouth.”
We have been fortunate to see the impact of a long period of expansion on stock market returns. Do consider it a gift for now, although the actual dynamics of the expansion-recession cycle and what it means for you are important issues.
The official definition of recession is the period between a peak and trough of national GDP, and expansion is the period between a trough and the next peak. The figure below shows statistics on US economic cycles over the last 50 years based on information collected by the National Bureau of Economic Research. Most of the time, five out of six years, we are in a growth period. Occasionally, say one in six years, we drop into a contraction period that is called a recession. During an expansion, risky assets like stocks perform better than average, while they perform worse than average during a recession, as you would expect. The average recession lasts about one year and the normal range is 6 to 18 months. Expansions last longer than recessions, almost six years on average, but the length of an expansion has varied widely from one to ten years.
There is no denying that the current expansion is now at the long end of the distribution of prior expansions. The present expansion began in July 2009 but was for several years a weak recovery with high unemployment, even though it was artificially supported by an accommodative monetary policy. More recently, the expansion has been bolstered by tax policy and other measures. For these reasons, it is misleading to compare the age of the current expansion to prior expansions. Further, the data show that expansions and recessions do not occur at regular intervals. That means that we cannot predict when the next recession will occur based on the duration of the current expansion. That has not stopped financial analysts from trying to predict recessions by other means: slope of the yield curve, changes in consumer sentiment, changes in residential investment, etc. Presently, these signals are not indicative of an imminent recession nor are they considered reliable indicators in general.
Should you adjust your portfolio’s asset allocation to account for an imminent recession? If you were clever enough, hypothetically, to de-risk your portfolio (reduce holdings in stocks) in anticipation of a recession, you would be faced with a bigger problem: exactly when during the recession, should you re-risk your portfolio in anticipation of the next expansion? If you wait for the expansion to occur before re-risking, then you have waited too long and probably missed out on substantial gains. Such a strategy is highly impractical and ill advised.
The answer to this dilemma is the practice of investment humility. Recognize that neither you nor the “experts” can predict the beginning or end of a recession. Always use conservative assumptions about stock and bond returns that reflect the average performance of those assets in both good and bad times. Stay diversified and remain fully invested. As a long-term investor, following these guidelines will produce good performance relative to peers and, more importantly, help you attain your financial plan. And, in the meantime, don’t look a gift horse in the mouth!