Recessions and the Stock Market
There is much talk today that we may be headed for another recession. Our latest management letter, “Fishing for Confidence at Jackson Hole” includes a discussion of how the Federal Reserve, in an attempt to tamp down inflation, may create some unwanted economic side effects. Namely, higher interest rates, slower growth, and softer labor market conditions. The media is constantly bombarding us with this news.
What is a recession?
An economy is in a recession when it contracts for six months or longer. The definition most widely accepted is two quarters of negative Gross Domestic Product (GDP) growth. Since 1945 there have been 13 recessions in the U.S., with the last once occurring in 2020 during the initial COVID outbreaki.
Recessions vary considerably in depth, breadth, and length. Thankfully, not all recessions are as bad as The Great Recession / Financial Crisis. While it is certainly painful for folks who lose jobs and/or face financial uncertainty, the U.S. economy has always bounced back - and then some. Jobs come back and the economy rolls along. The chart below illustrates the unprecedented growth of the U.S. economy post World War II.
What happens to the stock market before, during and after a recession?
The S&P 500 actually rose an average of 1% during all recession periods since 1945. In over half of the 13 years with recessions since 1945, the S&P 500 has posted positive returnsii.
Why would the stock market go up during a recession? Well, picture this: You are an investor who analyzes the economy and the markets all day every day (e.g., us here at WFS). You spend your days forecasting future possibilities and probabilities so that you can make the best decisions as to where to invest. The key word here is future. Now multiply this by all of the other investors in the market. If the consensus opinion is that we are headed for a recession, then that consensus opinion is normally already priced into the stock market. Investors have already traded in their portfolios in anticipation of a recession.
The market typically begins to sell off before a recession. The chart below shows the stock market with the shaded areas representing recessions.
S&P 500 (log scale), Recessions in Shaded Areas
Source: S&P Global
The other thing about recessions is that we won’t officially know we are in one until after the fact. It takes a while to compile all of the data needed to make that call. We could be out of a recession before we even knew we were in one!
Most important: The stock market has fully recovered and continued to go up from there following every recession. Every single one. I believe that trend will continue going forward. The majority of publicly-traded companies are in good financial shape. These firms can easily withstand any short-term blip in the economy. The world continues to develop. New middle class consumers create increased demand for products and services. Advances in technology and health care will continue to improve living conditions for people worldwide. In my opinion, now is a great time to start putting money to work for the long term.
Can I “recession proof” my finances?
If you haven’t already done so, now is a great time to update your financial plan. If you don’t yet have a financial plan, it’s a great time to begin talking with a professional about putting one together. Financial plans can provide peace of mind and alert you to any shortfalls or other important financial issues that need to be addressed - especially in times of uncertainty, such as a recession. If you have a solid financial plan and follow it, you just may be able to “recession proof” your finances, or at least have confidence in a plan that prepares you for life’s twists and turns.
So hang in there, and give us a call if you want to talk about it.
Read the Financial Planning Focus November 2022:
iNational Bureau of Economic Research
iiCFRA Research, Federal Reserve
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