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Friday, July 01, 2022
Surprising Historical Facts about Recession and Market Returns
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* This performance is only observed with historical backtests and not traded by the company.
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The S&P 500 is down nearly 20% so far this year, making it Wall Street’s worst first six months of performance since 1970. Investors are concerned that when the Federal Reserve tightens monetary policy, it won't be able to achieve a "soft landing"—bringing down inflation without impairing economic development. Historically, when the Federal Reserve has worked hard to quell raging inflation, recessions have followed more often than not.
Defined as two consecutive quarters of GDP decline — after World War II there have been 13 recessions–with 3 in the 21st century itself (2001, 2008 and 2020), according to the National Bureau of Economic Research. Most experts and economists believe another one could be on the way.
Recessions in the past have caused major market crashes, no wonder why stock market investors are nervous, causing many blue-chip stocks to correct sharply. However, stock markets and the economy might not always be in sync with one another. At times markets may be slow to react to economic data, however more often the stock market front runs the economy.
So, how do stocks perform when the economy is faced with a recession?
Surprisingly, the S&P 500 rose an average of 1% during all recession periods since 1945 (refer table below). That’s because markets usually top out before the recession starts and bottom out before it ends.
In other words, the worst is typically over for stocks before it’s over for the rest of the economy. In almost every case, the S&P 500 has bottomed out nearly four months prior to the end of a recession.
Since World War II, there have been 13 recessions, and more than half of those years have seen positive returns for the S&P 500. Most of the time, the pain manifests itself before the recession even starts. Equities often do poorly in the six months just before a recession. On the other hand, the index typically hits a high seven months before the start of a recession.
According to the historical data (in the table below), the stock markets have performed very well once a recession ends. The average forward one-year, three-year, five and ten-year returns for the S&P 500 index following a recession are +14%, +30%, +57% and +149% respectively. These numbers do not even include the dividends received.
S&P 500 Performance Around Recession
|Recession start date||Recession End date||Six months prior to Recession||During Recession||One year after Recession||Three years after Recession||Five years after Recession||Ten years after Recession|
|Probability of positive returns||46.2%||53.8%||84.6%||100%||100%||100%|
Data Source : Bloomberg
Past performance doesn’t guarantee future returns.
The numbers do not include the dividends received.
Now comes the key question- what’s next for the markets? Is the worst over or could we witness further sell-off?
Market turbulence is never simple. Even seasoned investors cannot predict when stocks will bottom out. There’s a chance that the bear market could get worse before it gets better.
The typical bear market over the previous 80 years saw equities decline by an average 35% from their peak in a little over a year. Having said that, during the last three recessions since 2000, the markets lost an average of a mere 16%. For example, during the covid recession 2020, which officially lasted for only two months from February 2020 to April 2020, markets lost only 1% (refer to table above). Although, at its trough markets were down by more than 30%, at the official end of the recession i.e April 2020, markets had recovered most losses and were down by merely 1%.
So during a recession, markets can fall significantly, but they usually bottom out before the recession actually ends. Given that S&P 500 is currently down by more than 20%, the benefits of staying invested appear to offset the risks in the long run.
Ultimately, for long-term investors, it is more important to be well-positioned for expansions than to try to time recessions. Diversification across asset classes and concentration on higher-quality investments could help investors steer the heightened volatility, while putting them in a better position to benefit from the next upcycle.
Risks and Assumptions for Back-tested trading strategies
Data Source: Bloomberg
Data & Prices as of: 01/07/2022
Arun Leslie John
Chief Market Analyst
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