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Will A Recession Sink Stocks? Thumbnail

Will A Recession Sink Stocks?

Some investors worry about the stock market sinking if a recession is officially announced. And while it can get worse from here, history shows that markets incorporate expectations ahead of economic reports. Quite often, by the time a recession is officially announced markets have moved on higher.

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History suggests that investors may end up worse off changing their plans after the official announcement of a recession and based on fears of tougher times ahead.

Category: Financial Roadblocks


The global financial crisis highlights this same lesson and the forward-looking nature of the stock market. The U.S. recession spanned from December 2007 to May 2009, as indicated by the shaded area in the chart.

U.S. RECESSION AND STOCK PERFORMANCE DURING THE GLOBAL FINANCIAL CRISIS1

S&P 500 Index, January 2007–December 2010

Recession Announced: The official “in recession” announcement came in December 2008—a year after the recession had started. By then, stock prices had already dropped more than 40%2, reflecting expectations of how the slowing economy would affect company profits. Historically, U.S. stocks have struggled in the first half of recessions, with negative returns occurring before the announcement of the recession. 

End of Recession Announced: Although the recession ended in May 2009, the “end of recession” announcement came 16 months later (September 2010). U.S. stocks had started rebounding before the recession was over and climbed through the announcement. Historically, during the second half of a recession, investors have historically enjoyed positive returns.


Recessions are proclaimed with a delay

The National Bureau of Economic Research (NBER) identifies phases of the business cycle using many different indicators, such as consumption and income data, employment rates, and gross domestic product growth. None of these measures have been consistently dominant in the determination of economic conditions. Further, past U.S. recessions have come in all shapes and sizes. Recessions are therefore named retroactively, with the benefit of hindsight (and additional economic data that may be available with a lag).

In the COVID-era recession of 2020, for example, the market’s low point came in March, three months before the announcement in June 2020. 

Because recessions are proclaimed with a delay, rather than in real-time, markets are often on the way toward a recovery by the time of the announcement. As shown below, the stock market had already bottomed out prior to the announcement month in two-thirds of recessions since 1980. (Prior to 1979, the NBER did not formally announce recessions.) 

Recession Announcements vs. U.S. Stock Market Lows


Recessions seem to be a normal part of positive change and growth. “A Wealth of Common Sense” blogger Ben Carlson lists nearly three dozen distinct U.S. recessions dating back to the 1850s, with an average length of 17 months. Yet, when these periods are viewed with their counterparts, the good times have been disproportionately longer and stronger than the bad times. Consider the growth since the end of World War II, when the U.S. stock market was priced at approximately 16. The same index is priced today at approximately 4,000.

So, if and when a recession is declared, reducing exposure to stocks at that point may lead to missing out on brighter days ahead.

Read more of our thoughts on Market Downturns, here


Look past mid-year declines

Sudden market downturns can be unsettling. And after negative periods of returns, it is natural to wonder if more pain is to come. 

But historically, U.S. stock returns following sharp downturns have, on average, been positive.3

Stock Returns After 20% Drawdown

Fama/French Total US Market Research Index Returns, July 1926 - December 2021


Markets can get a lot worse before they get better, but they are still expected to get better.

Investors who look beyond after-the-fact headlines and stick to a plan may be better positioned for long-term success.



 

Past performance is no guarantee of future results. Short-term performance results should be considered in connection with longer-term performance results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.

Source: Dimensional Fund Advisors © 2022

  1. Start and end dates of U.S. recessions, along with announcement dates, are from the National Bureau of Economic Research (NBER). nber.org/research/data/us-business-cycle-expansions-and-contractions and nber.org/research/business-cycle-dating/business-cycle-dating-committee-announcements
  2. Decline based on the U.S. stock market as represented by the S&P 500 Index’s price difference between the actual start of the recession in December 2007 and the official “in recession” announcement 12 months later. S&P data © 2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
  3. The average annualized returns for the five-year period after 10% declines were 9.54%; after 20% declines, 9.66%; and after 30% declines, 7.18%. Market declines or downturns are defined as periods in which the cumulative return from a peak is –10%, –20%, or –30% or lower for equities and -2% or lower for fixed income. Returns are calculated for the 1-, 3-, and 5-year look-ahead periods beginning the day after the respective downturn thresholds are exceeded. The bar chart shows the average returns for the 1-, 3-, and 5-year periods following the 20% for equities and 2% for fixed income thresholds. For the 10% threshold, there are 29 observations for 1-year look-ahead, 28 observations for 3-year look-ahead, and 27 observations for 5-year look-ahead. For the 20% threshold, there are 15 observations for 1-year look-ahead, 14 observations for 3-year look-ahead, and 13 observations for 5-year look-ahead. For the 2% threshold, there are 29 observations for 1-year look-ahead, 26 observations for 3-year look-ahead, and 25 observations for 5-year look-ahead. For the 30% threshold, there are 7 observations for 1-year look-ahead, 6 observations for 3-year look-ahead, and 6 observations for 5-year look-ahead. Peak is a new all-time high prior to a downturn. Data provided by Fama/French and available at mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. FAMA/FRENCH TOTAL US MARKET RESEARCH INDEX 1926—present: Fama/French Total US Market Research Factor + One-Month US Treasury Bills. 
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