Portfolio Design: A Modern Approach to Asset Allocation

LESSONS OF THE RECENT DOWNTURN

When the economy hits a downturn, businesses suffer. So it is not surprising that stock markets also suffer. Sometimes the drop in the stock market is severe, so portfolios are devastated. Investors inevitably wish that they had not taken chances in the stock market. Bonds are the place to be.

Since 1951, there have been nine recessions in the United States including the recession that began in December 2007.4 The recessions themselves will be timed using the NBER’s dating scheme. The National Bureau of Economic Research (NBER), a non-partisan research organization based in Cambridge, Massachusetts, has been dating recessions since the 1940s. In every one of these recessions, there has been a sizable fall in the U.S. stock market. The stock market typically begins its fall before the start of the recession, perhaps because investors anticipate the recession and the subsequent fall in corporate profits. Table 1.1 gives the dates of each recession as well as the dates when the S&P 500 index reached its peak and trough. These peaks and troughs are measured using monthly averages of the daily S&P 500 index.

TABLE 1.1 Stocks and Bonds in Recessions, 1951–2009

The returns reported in Table 1.1 extend back to the early 1950s. Ibbotson SBBI Yearbooks (©Morningstar) report monthly stock and bond returns extending back to 1926.5 These returns will be used in ...