Recessions and the Stock Market

November 30, 2022
by Glenn Guard, CFA
Bull and bear statues on Wall Street. West Financial Services

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.

"Chart: Gross Domestic Product. Billions of Dollars on left axis ranging from 2,000 to 22,000, time periods on horizontal axis.  Time periods are every five years beginning with Q1 1950 through Q1 2020. Q1 1950 is 280.828. Q1 1955 is 413.073.  Q1 1960 is 542.648. Q1 1965 is 717.790. Q1 1970 is 1,051.200. Q1 1975 is 1,616.116. Q1 1980 is 2,789.842. Q1 1985 is 4,230.168. Q1 1990 is 5,872.701. Q1 1995 is 7,522.289. Q1 2000 is 10,002.179. Q1 2005 is 12,767.286. Q1 2010 is 14,764.611. Q1 2015 is 17,991.348. Q1 2020 is 21,538.032. Source: U.S. Bureau of Economic Analysis"

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

"Chart: S&P 500 Historical Price. Price on left axis ranging from 10 to 10,000, time periods on horizontal axis.  Time periods are every ten years beginning with 1940 through 2020. February 1940 is 258.21. January 1950 is 216.21. January 1960 is 565.61. February 1970 is 701.86. January 1980 is 437.23. January 1990 is 769.72. January 2000 is 2,461.22. February 2010 is 1,518.67. January 2020 is 3,725.48. Source: S&P Global"

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.

Meet Glenn Guard, CFA »

Read the Financial Planning Focus November 2022:

"Thank You" »

"The Year End Gift You May Not Be Expecting"   by Brian J. Horan, CPWA® »

"Gauging Forward Return Expectations" by Ryan Streilein, CFA »

  iNational Bureau of Economic Research
  iiCFRA Research, Federal Reserve

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