December, 2022
Negative stock returns and aggressive U.S. Federal Reserve interest rate hikes have many concerned that another Big Recession is coming — if we’re not already there. Media commenting on the possibility creates even more worry about markets sinking further among investors. Investors often delay taking actions to sell only when a recession is officially announced.
History shows, however, that markets incorporate recession expectations months ahead of economic reports. By the time one is called, the worst of the market declines has usually already occurred.
- The global financial crisis offers a lesson in 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.
- But the official “in recession” announcement only came in December 2008 — a year after recession had started. By then, stock prices had already dropped more than 40%, reflecting collective participant expectations of how the slowing economy would affect company profits.
- Although the recession ended in May 2009, the “end of recession” announcement came 16 months later (September 2010). US stocks had started rebounding well before the recession was over and continued to climb after the official announcement.
Exhibit 1: US Recession and Stock Performance During The Global Financial Crisis
S&P 500 Index, January 2007–December 2010
Decline based on the S&P 500 Index’s price difference between the actual start of the recession in December 2007 and the official National Bureau of Economic Research “in recession” announcement 12 months later. Announcement for the end of recession was 16 months after the actual ending.
Recessions are always identified officially with a lag. The National Bureau of Economic Research (NBER) identifies phases of the business cycle using a bevy of indicators, such as consumption and income data, employment rates, and gross domestic product growth. None of these measures has been consistently dominant in the determination of economic conditions, and certainly past U.S. recessions have come in all shapes and sizes. Recessions are therefore named retroactively, with the benefit of hindsight (and the additional economic data that is available with a lag).
Exhibit 2: Official NBER recession announcements vs. US stock market lows
Start and end dates of US recessions, along with announcement dates, are from the National Bureau of Economic Research (NBER): Business Cycle Dating Committee Announcements and US Business Cycle Expansions and Contractions.
Financial markets are constantly processing new information, pricing in expectations for companies and the economy. Because recessions are invariably proclaimed after a delay, rather than in real time, markets are often well on the way toward a recovery by the time an official announcement is made. As shown in Exhibit 2, the stock market had already bottomed out prior to the announcement month in two-thirds of recessions since 1980. In 2020’s recession, for example, the market’s low point came in March, three months before the announcement in June 2020.
Conclusion
The takeaway for planning investment strategy? Looking beyond the hype of media headlines, and sticking to an informed planning approach based on research from financial science, better position you for successful outcomes. When a recession is officially declared, we believe the most sensible approach is to ignore it and remain disciplined when holding a well-diversified asset allocation within your risk tolerance and capacity. Reducing exposure to stocks after an announcement is made is more likely to lead to missing out on a recovery that may have already begun.
Don’t let market swings or media messages drive impulsive choices. Have realistic expectations about the range of likely outcomes based on a thoughtful investment policy. And have a trusted CFP® professional help when you cannot trust yourself.