We are probably already in a recession. The US economy shrank for the second quarter in a row, with gross domestic product (GDP) falling 0.9% in the second quarter after falling 1.6% in the first quarter. Two consecutive quarters of falling GDP are seen by many as the beginning of a recession.
But officially the US won’t be in recession until eight economists say so. These economists serve on the National Bureau of Economic Research’s Business Cycle Dating Committee.
Investors won’t wait for an official recession announcement to worry about the stock market. But how does the market perform during a recession? That’s what history shows.
An ugly chart
The S&P 500 does not fully represent the entire stock market. It includes only the 500 largest publicly traded companies listed on US stock exchanges. However, the S&P 500 index has long been considered a good indicator of the market as a whole. And since the index has been around for 65 years, it gives us a look at how the stock market has performed during most of the post-World War II recessions.
Since the inception of the S&P 500 in 1957, there have been 10 official recessions in the United States. The following graph shows how the index developed during these periods.
The S&P 500’s worst decline occurred during Great recessionwhich began in December 2007 and lasted until June 2009. The index has fallen 55% below its previous peak in March 2009.
However, this was a much more severe recession than usual. The average decline in the S&P 500 during the post-WWII recession is about 29%. However, this average is skewed in part because of the particularly steep sell-off during the Great Recession. The median drop is about 24%.
Not surprisingly, the S&P 500 has always declined during recessions. Many companies are reporting lower revenues as consumers tighten their wallets. Investors often react negatively to any bad news.
The best performance for the S&P 500 during a recession was a 20% decline in 1990. The recession was short and lasted only eight months.
Two important details
There are two important details about how the S&P 500 has performed during recessions. First, in many cases the index fell significantly long before the official onset of the recession. Second, the S&P 500 has often started to recover well before the end of a recession.
A decline in the S&P 500 prior to the onset of a recession makes sense. Investors tend to be prudent. Most recessions don’t happen out of the blue, although the 2020 COVID-19 recession was exceptional.
Investors usually see signs of a potential recession long before it is officially announced and often become more cautious in advance. This risk-averse psychology can affect stocks before a recession hits.
But that same forward-thinking mentality is also helping stocks start to recover before the recession officially ends. Again, the economic improvement that leads to the end of a recession usually does not happen immediately.
Investors are watching for hints that a turnaround is coming. When they see positive indicators, they start buying stocks more aggressively. This often causes a bandwagon effect, with even more investors jumping into the stock market.
Reasons for optimism
A look at past S&P 500 performance should give investors reason for cautious optimism. The index is currently down about 18% and is more than 20% below its previous peak just a few weeks ago. The S&P 500 has no more room to fall to reach its average recessionary decline.
More importantly, the S&P 500 has rebounded sharply after every recession we’ve had. And it often began a major rebound long before the end of the recession.
This is good for long-term investors. The current market downturn should provide an excellent buying opportunity for those with the patience to hold out for a few years. This is true whether a recession is looming or not.
10 Stocks We Like More Than Walmart
When our award-winning team of analysts has an investment tip, it’s worth listening to. After all, the newsletter they’ve been publishing for over a decade Motley Fool Stock Advisortripled the market.*
They just revealed what they believe top ten stocks for investors to buy right now… and Walmart was not one of them! That’s right – they think these 10 stocks are an even better buy.
Fund Advisor returns as of 02/14/21
The Spotted Fool has a disclosure policy.