Signal From Static: What Happens to Stocks During Recessions?

Signal From Static: What Happens to Stocks During Recessions?

What Happens to Stocks During Recessions?
President Harry Truman is credited with saying, “It’s a recession when your neighbor loses their job; it’s a depression when you lose yours.”

If that’s the case, then the incredibly tight labor market and its 3.7% unemployment rate would suggest we’re nowhere near recession. Yet for many pundits, analysts and prognosticators, the expectation is that recession is near and this will create more pain for equity investors.

However, we’ve already experienced quite a bit of pain in the stock market. Maybe, just maybe, the worst, if not behind us, is mainly in the rearview mirror.

I tapped Adviser Senior Research Analyst Liz Laprade, CFA, to help cut through the noise that has permeated rational discussion around the relationship—or lack thereof—between recessions and market downturns.

First, let’s set the stage. The U.S. economy is growing. After two fractionally negative quarters during the first half of 2022, gross domestic product expanded 0.7% in the third quarter after taking inflation into account.

Typically, two quarters of economic contraction would signal recession. Yet the official arbiter, the National Bureau of Economic Research, has not labeled it as such. Let’s turn to Liz’s data.

This table shows periods of recession, their duration and what happened to the S&P 500's returns and company earnings 12-months prior to recession, during recession and in the 12 months following.
Note: S&P 500 columns show index-level returns excluding reinvested dividends over the periods displayed. Sources: S&P/Dow Jones, Adviser.

What you’ll see is that, on average, stocks have risen in the 12 months prior to the 10 recessions we’ve experienced over the past 65 years, and they’ve fallen an average of just 3% during these periods of economic contraction. Post-recession, stocks have seen double-digit gains over the ensuing 12 months in all but one instance.

If indeed we are headed for a 2023 recession, as so many pundits are predicting, then this will be a very atypical period given that stocks have been falling over the past year. The S&P 500 is down 11% over the 12 months ending in November, about double the worst pre-recession performance historically.

Meanwhile, corporate earnings have typically risen prior to recessions and then fallen both during and after recessions as growth ramps back up.

This time, though, earnings are already falling. With almost all the data in, third-quarter operating earnings for S&P 500 companies are down about 3% compared to a year ago and reported earnings per share are down 11%. Expectations are that the current quarter’s earnings will fall even further below where they were in 2021. Again, this is atypical and could signal that, for investors at least, the pain that recessions typically bring may have already been wrought.

The bottom line for me is that while the current recession talk is loud and pervasive, it isn’t persuasive. Like so many of the economic and market metrics that were thrown off-kilter by the near-total global economic shutdown of 2020, current thinking on recessions and market responses may be what’s out of whack this time.

This material is distributed for informational purposes only. The ideas and opinions contained herein  should not be viewed as recommendations or personal investment advice. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Our statements and opinions are subject to change without notice. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.

Past performance is not an indication of future returns. Tax, legal and insurance information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice, or as advice on whether to buy or surrender any insurance products. Personalized tax advice and tax return preparation is available through a separate, written engagement agreement with Adviser Investments Tax Solutions. We do not provide legal advice, nor sell insurance products. Always consult a licensed attorney, tax professional, or licensed insurance professional regarding your specific legal or tax situation, or insurance needs.

For a summary of Adviser Investments’ advisory services and fiduciary responsibilities to our clients, please review our Form CRS here.

© 2022 Adviser Investments, LLC. All Rights Reserved.