How much should an investor worry about another recession?

The drumbeat of negative economic predictions continues as more forecasters predict that a recession began late in 2007 or will arrive early in 2008. The latest convert is former Federal Reserve Chairman Alan Greenspan, who recently put the odds of a recession at 50% or better. The U.S.economy has been expanding since the last recession ended in 2001 and signs that the economy has slowed are evident in corporate profits and the housing market.  Still, the future is impossible to predict, and no one can reliably forecast whether a recession is coming tomorrow or ten years from now.

Recessions have a nasty habit of taking stock market profits away, at least temporarily. The U.S.stock market, as measured by the Standard & Poor’s 500 Index, has fallen an average of 26% during the 11 recessions since 1945. The average recession since 1945 has lasted only 10 months, vs. the average 57 months of economic expansion, says the National Bureau of Economic Research, the group charged with declaring the beginnings and ends of recessions. The longest since World War II were the 16-month declines in 1973-75 and 1981-82. The most recent recession, in 2001, lasted just eight months.

How concerned should an investor be? Recessions are short-term events that are usually over in a year or less. An investor who has a balanced portfolio that includes stocks, bonds, and cash and who has a time frame of more than two years shouldn’t be too concerned. Although stocks often (but not always) fall during a recession, bonds usually perform well, keeping a balanced portfolio from falling as far as the stock market. Sometimes cash investments generate high returns, as in 1973-75, and also shelter the portfolio.

Anyone investing new money should welcome the temporary declines that come with a recession, because they get to buy more shares at cheaper prices. The stock market recoveries that develop at the end of recessions (and are as unpredictable as recessions) can quickly erase the previous declines. For instance, the S&P 500 rose by 37% in 1975 and by 30% in 1991 after recessions drove the markets down.