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Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors.
Before trading, please ensure that you fully understand the risks involved
Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors. Before trading, please ensure that you fully understand the risks involved

Friday, July 01, 2022

Surprising Historical Facts about Recession and Market Returns

By Century Financial in Investment Insights

Surprising Historical Facts about Recession and...
Surprising Historical Facts about Recession and Market Returns

* Trading in financial market carries risk and can result in loss of capital.
* This performance is only observed with historical backtests and not traded by the company.


The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.

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
Feb-45 Oct-45 6% 23% -11% 0.3% 17% 154%
Nov-48 Oct-49 8% 4% 22% 53% 98% 258%
Jul-53 May-54 -9% 21% 30% 60% 100% 175%
Aug-57 Apr-58 7% -8% 33% 50% 61% 125%
Apr-60 Feb-61 -3% 15% 10% 23% 44% 53%
Dec-69 Nov-70 -10% -6% 8% 10% 4% 57%
Nov-73 Mar-75 1% -22% 23% 7% 22% 117%
Jan-80 Jul-80 4% 15% 8% 33% 57% 193%
Jul-81 Nov-82 -4% 7% 20% 45% 66% 211%
Jul-90 Mar-91 0% 4% 7% 23% 73% 207%
Mar-01 Nov-01 -18% -8% -18% 3% 23% 9%
Dec-07 Jun-09 -4% -37% 12% 49% 113% 222%
Feb-20 Apr-20 2% -1% 44% NA NA NA
Average Returns -2% 1% 14% 30% 57% 149%
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
The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
Unforeseen events can lead to variation in performance from the tested trading strategy.
The tested result has been computed with price feeds available from Bloomberg.
The testing environment has not considered transaction or any other costs.
Trading indicators used for the purpose of testing has been provided by Bloomberg.
The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Data & Prices as of: 01/07/2022

Arun Leslie John
Chief Market Analyst

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