Every stock market recession has a cause. And the recessions that cause them don’t come out of nowhere. However, they are difficult to predict in advance. Far better to cut your risk by investing in a well-balanced portfolio of stocks that meet our Successful Investor criteria.

Every stock market recession has a cause. And the recessions that cause them don’t come out of nowhere. They start because something sets them off. For instance, the recession that ran from December 2007 to June 2009 grew out of the subprime mortgage crisis. This crisis was mainly the result of loose mortgage lending, which spurred rampant speculation and even fraud in U.S. mortgage securities and real estate.

The previous three recessions came at roughly 10-year intervals. The early 2000s recession grew out of the collapse of the mass speculation in start-up Internet companies, coupled with the September 11 terrorist attacks of 2001. A sharp rise in oil prices also weighed on the economy. Still, this recession was short. It lasted just 8 months, from March 2001 to November 2001. It was also shallow—economic activity shrank by just 0.3% from peak to trough. Unemployment hit a peak of 6.3%.

The early 1990s stock market recession grew out of a sharp rise in both interest rates and oil prices. The U.S. Federal Reserve set off the rise in interest rates, to combat the rise in inflation that had been going on since the late 1980s. Oil was already rising in August 1990, when Saddam Hussein sparked a sharper rise by invading fellow oil producer Kuwait. The early 1990s recession also lasted 8 months, from July 1990 to March 1991. Economic activity shrank by 1.4% from peak to trough. Unemployment hit a peak of 7.8%.

The early 1980s stock market recession also came about due to a rise in oil prices, which helped spur an already high level of inflation, plus the high interest rates that came in response to the high inflation. This recession lasted a year and 4 months, from July 1981 through November 1982. The economy shrank 2.7%. Unemployment hit a peak of 10.8%

But back to the 2007 to 2009 stock market recession. It lasted for 18 months, from December 2007 to June 2009. That made it the longest recession since the Great Depression of the 1930s. (The 1930s recession lasted 3 years and 7 months, from August 1929 to March 1933.) Unemployment peaked at 10% in the most recent recession, its highest rate since the early 1980s peak of 10.8%. The economy shrank 4.3%, its deepest setback since the 8-month postwar recession of 1945. (In the 1945 recession, the economy shrank 12.7% as activity shifted back from a military to a peacetime emphasis. Unemployment peaked at the relatively low level of 5.2%.)

Our view of stock market recessions

Our view is that recessions tend to occur as an unintended side-effect of government policies, foreign and/or domestic. For instance, there’s a recurring pattern in which the U.S. Federal Reserve holds interest rates down to spur economic growth. The economy performs as the Fed hopes, and grows quickly. This growth comes with a spurt of inflation. The Fed reacts by sparking a rise in interest rates, to combat inflation. That makes borrowing more costly for consumers and business to borrow, so they cut back on their spending. This quells the inflation, but helps bring on the next recession.

Be skeptical of stock market recession indicators

You need to avoid putting too much faith in the stock market as an economic forecaster. However, sometimes the market gives advance warning about coming recessions and economic bubbles. Other times, it predicts economic bubbles that never come. (This, by the way, is true of any economic forecast.)

Up to a point, national and world economies are self-correcting. They rise and fall in a series of spurts and setbacks. The setbacks always show some sign of turning into recessions. They rattle investors and upset the market. But few ever lead to serious, lasting damage.

The most experienced, successful investors are skeptical, if not downright cynical, about economic forecasts, for three reasons:

1. Accurate economic forecasts are rare—certainly rarer than profitable stock market recommendations.
2. Fame as an economist has little to do with forecasting skill.
3. Even when an economic forecast is right, it still may not offer helpful investing advice. Far better to stick with a well-balanced portfolio of stocks that meet our Successful Investor criteria.

How to invest to avoid significant losses during recessions: Take a conservative approach

Our conservative Successful Investor strategy will help maximize your returns.

Lower risk investments equate to safer investments. For conservative investing, focus on investing in high-quality stocks—especially those that offer hidden value. That’s because high-quality stocks make better long-term investments. They tend to recover faster from a setback, and are more likely to go on to new peaks. Low-quality stocks are more likely to stay down, or take longer to recover.

What do you think some contributing factors will be for the next stock market recession?

Even though most stock market recessions aren’t as bad as economists portray them, it’s always smart to prepare for them. What steps do you take to limit the adverse effects of a recession on your investment portfolio?