Historical Recessions and the Stock Market

The stock market does not reflect current economic conditions, but rather forecasts conditions, typically 6 months or more, into the future.   So the stock market’s poor performance is indicative of what?

According to the National Bureau of Economic Research, a recession can be defined as

“a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches it’s trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.”

Looking back on the last 9 recessions (since 1953) provides valuable clues as to how this current one may play out.

• On average, recessions last 11 months. Stocks begin their descent 6 months earlier,  and it lasts about 12 months, or into the middle of the recession.  During this period the average return on stocks was a negative 21%.

• Then, as the markets discounts economic recovery, the returns turn positive, and the upward slope for stock prices averages a +36% return.

• Through the entire “recession cycle”, investors have averaged +8%.

The worst return, pre-recession to post-recession, since 1953, began in 2000, when the dot-com bubble burst,  the 9/11 attacks occurred, and corporate accounting scandals were headlines.
Investors suffered a loss of 30% pre-to-post-recession, then in 2003 the they enjoyed a gain of 28.5% .

The next worst was Nov ’73 to March’75, a loss of 22%,during OPEC price-quadrupling, Watergate scandals, and Vietnam War spending.

From June 2007 through June of 2008, the S&P 500 has lost  18.25%.  So we may have more time and further stock price reductions.

….Or not. The problem is that these things are not predictable. The economy is a model of complex pulleys, wheels, and levers. There are many possible outcomes.

But we do know that patient investors average 8% from pre to post-recession, on average, if they simply weather the full market cycle.
Well-allocated investors can reduce the peak-to-trough impact and “smooth the ride” by owning a sensible bond fund or ladder, which typically perform well when interest rates decline. Interest rate declines are common when stock prices are falling.

-Sources include: Jennison Dryden