Here is a recent Q&A on Recessions.

Question: The US economy is in a recession. Does it make sense to own stocks during a recession?

Answer: There is no evidence that market timing in response to economic events enhances expected returns. The market tends to lead economic activity. Stock prices tend to fall in advance of recessions and rise in advance of economic upturns. To time markets successfully, you have to come up with better forecasts of economic activity than those already built into stock prices. We don’t know anyone who can do this.

Moreover, investors who try to time the market by selling after news of a recession is already in prices are probably reducing their expected returns. Although realized returns are too volatile to make strong statements, there is some evidence that expected stock returns are relatively high during recessions and low during expansions. One can avoid the higher risk of stocks during recessions, but apparently only by passing up higher expected returns. —EFF/KRF

“Something that everyone knows isn’t worth knowing.” – Bernard Baruch. 

Baruch was referring to individual stocks, but I take his meaning to include the economy and “the stock market” as a whole. If something is already known, it will have no further influence on individual stocks or the stock market. It is only something new that will affect prices.

Larry Swedroe is the co-author of The Only Guide to Alternative Investments You’ll Ever Need.

In a recent interview with HardAssetsInvestor.com, he talked about commodities, portfolio construction and investing strategy. He also related his outlook for the U.S. economy as a whole to his view on future returns in the stock market. Surprisingly, he is optimistic.

I know, firsthand, that a great many investors are discouraged and/or disgusted with the downturn in the economy, in general, and the decline in the markets, specifically, over the past months. Some investors have fled the stock market for safer investments. And, yes, I realize that it is difficult to find any silver lining in the current dark clouds of the economy.

Certainly, the volatility of the stock market cannot make anyone feel peaceful. It’s clear that optimism is in short supply.

Nevertheless, Swedroe thinks this may be a good time to invest in stocks. Please, consider his logic, which I personally find very persuasive.

HardAssetsInvestor.com: What are your general thoughts about the economy and the stock market here?

Swedroe: The big picture is simply this: Clearly, this is the worst economic crisis we’ve seen since the Great Depression. But wait … did I tell you anything you didn’t already know? The markets know that too. This is the worst market since the Great Depression.

We all know the economic news is going to get worse. Unemployment is going to go up; retail sales are going to go down. But while everyone’s focusing on the bad economic news, they’re forgetting that the market has already understood this.

People are saying, why can’t this be another Great Depression? And it could; you can’t rule that out. But what people fail to understand is this: In the Great Depression, the policy responses were all in the wrong direction. We raised taxes and raised interest rates, increased margin and reserve requirements, and started a trade war. The policy responses this time, whether you agree with them or not, have not only been in the right direction – cutting interest rates, flooding the markets with liquidity, etc. – but they have been the most massive effort ever.

The effort is coordinated around the globe, and countries are pledging to maintain free trade. Every major country is enacting fiscal stimulus programs, all the central banks are cutting interest rates, etc. So while we have had a massive economic crisis, offsetting that are the largest policy responses in history coordinated around the globe. Policy responses take a while to work through the system, while the economic news will continue to look bad for a while.

Remember: Just when things look darkest, stocks tend to have good returns. Prior to this year, when consumer confidence has fallen below 50, the average return for stocks the next year was 16%.

Or consider this: When the unemployment rate is below 4.3%, the average return to stocks is 2%. When the unemployment rate is over 6%, the average return to stocks is 15%.

In the 11 recessions in the post-war era, the cumulative return to stocks is up 7%, and T-bills are up 5%. Returns were positive and better than the risk-free rate. Every time an investor sold stocks and paid taxes, they would have been better off sitting pat in stocks. The only way to do better would have been to forecast the recession, and who can do that?

I cannot guarantee that we will get out of this crisis, but we have gotten out of every other crisis quite well.

(Emphasis added)

Conclusion

Certainly, there is no shortage of bad economic news: Home prices are falling, unemployment is rising, the stock market has had one of its worst years on record, and the automobile industry is asking the federal government for bailouts, like the financial services industry before them. Where will it all end? Is there any good news?

Indeed. Unfortunately, we do not know when the good news will arrive. But, what we do know is that whatever negative that can be said about the economy is already known. If it is widely known, then the bad news is already reflected in current stock prices.

If history has any relevance, and I think it does, after a stock market decline, when pessimism is commonplace, is a very good time to expect stocks to have higher returns.

This may be counterintuitive, but it is true, historically.