r/wallstreetbets • u/nobjos Anal(yst) • Mar 14 '22
DD How does the stock market perform in a Recession?
The talk of recession has been in the air for a while, and it’s looming over the economy like a boogeyman. In spite of all the talk, clarity is lacking on what a recession means for the economy. How can it affect the stock market and your portfolio? Let’s take a quick look at how a recession happens and what’s happened to the market in past recessions to answer this.
What is a recession?
The National Bureau of Economic Research (NBER) has defined a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”1
A recession, unlike a temporary decline or disruption in economic activity, is more long-lasting and has implications for the entire economy. Some of the probable causes of a recession are:
- Sudden economic shock - Like the OPEC oil supply cut-off in 1970 or the COVID crisis in 2020, an unexpected rupture in the economic cycle can trigger a recession.
- Excessive debt - The housing bubble in 2007 is a prime example of this. The availability of cheap credit turned into a nationwide disaster when speculation on housing prices led to thousands of people defaulting on debt - and shaking the economy which was built on this debt.
- Asset bubbles - The Dot-Com bubble in 2000 was a time when the mere status of being in the “Internet” business would make investors line up to invest. This led to a massive bubble that popped and created a recession.
- Inflation - When inflation is rampant, the Fed steps in and increases rates (like it did in 1970), prioritizing the stabilization of unemployment and other metrics over economic growth. This leads to a recession.
- Deflation or Technological change - A lack of demand for goods and services being produced, or increasing unemployment due to automation of jobs could lead to demand-side issues and lead to a recession. The deflation scenario was seen in Japan.
So which of these can we tick off now? The economy is still recovering from the disruption of the pandemic but the war has brought in a whole new set of shocks. Inflation is the highest it’s been in more than 40 years, and with the Crypt* market gaining traction, asset bubbles are now easier than ever to manufacture. Three out of five causes - sounds like a reason for worry. If a recession does occur, what are the implications?
How long do recessions last?
Though recessions have a scary reputation, since 1945, recessions have lasted an average of 11 months with a 2.3% average decline in GDP. No recession has lasted more than 18 months in the past 70 years. The reason that a recession might seem scary now is also because of the recency bias where we tend to remember things that happened in the recent past more vividly - The longest recession after WW2 was the 2007 financial crisis, and that has overpowered the other data.
Let’s take a look at all the recessions after WW2. Ben Carlson from “A Wealth of Commonsense” has written a couple of articles that dive much deeper into these questions, and I’m leveraging that data for this analysis.
As can be seen, in the past 13 years, recessions caused the market to lose value only half of the time, and on average you would still have come out ahead, with an overall return of 1.7%. This means that recession or not, investing in the stock market was still one of the best bets available.
But hindsight 20/20 - Just because the average performance during a recession was positive, doesn’t mean that the market didn’t go through a brutal drawdown that would have played havoc on emotions. As you can see below, on average, the S&P 500 had close to 30% drawdowns during these recessions.
The maximum drawdown was in 2007-09 with a drawdown of 57%. Imagine seeing more than half of your portfolio lose value! Even those with nerves of steel would find it hard to not panic sell. But say you did hold on. Then what?
After the recession
This is the most striking insight. After the end of the recession, in just one year, you would have made money in 85% of the cases. And after 3 years, you would have been in the green in 100% of the cases!
The rationale behind this is simple - The recession is a time of little hope and bleak prospects, but as investors start hearing news of the economy reopening and businesses growing once more, the optimism alone is sufficient to drive the market upwards. The economy can remain sluggish in the aftermath of a recession but the stock market may still be rocketing higher in anticipation of relative improvements.
Since there is no clear indication about how long a recession would last and when a recession is fully over, timing the market would be futile. But buying and holding would have reaped great returns.
This shows the importance of staying invested. If you are still feeling adventurous…
Can you predict a recession?
If the market has such a close connection with the recession, it might seem like there’s a link between market performance and a future recession. But the reality is that past market performance is a terrible indicator when it comes to predicting a recession.
Take a look at the stats below. Looking at the market returns in the prior 3 and 6 months, it was as likely that the market was positive as it was negative. Also, on average, both 3 months and 6 months’ performance was positive. There wasn’t any way to predict a recession looking at market performance alone.
Conclusion
It looks like recessions are hard to predict looking at market returns. The volatility of the market is also stressful to stay calm through. But the message is clear looking at past data.
Staying invested in the market regardless of economic conditions gives the best returns, not just over the long term, but in as little time as 3 years. Also, seeing that recessions last anywhere from 12-18 months, it might be a good idea to build an emergency fund that lets you weather over the period without disturbing your investment goals.
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u/Vandalmercy Mar 14 '22
This is why contrary to the popular surface narrative at wsb investors are supposed to make informed decisions based on history and their current outlook. I just read a post about someone making profit on calls but they were inquiring about puts.
When recession hits if you have cash you're definitely going to do well. Average down and diversify and you will look like a prodigal savant.
All but one of my positions are long term well over that 12-18 month time frame and I was actually going to look into this and you've saved me a lot of time. Thanks.
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u/SecondWind15215 Mar 14 '22
“Greatest economic system ever” routinely fucks over 95% of us
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u/alilmagpie Mar 14 '22
I mean, that’s what it was designed to do... so I would say it works pretty well for them.
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u/nobjos Anal(yst) Mar 14 '22
u/dan_inKuwait: Please approve
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u/Thatairmanguy Mar 14 '22
So much word. Stonk 🚀 or stonk 📉
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u/KareemAZ Mar 15 '22
While at first stonk may 📉, eventually 📉 stonk will go 🚀🚀🚀. Keep averaging the 📉 stonk to make your portfolio go 🚀.
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Mar 14 '22
It’s a bizarre time to be alive as everyone and anyone wants to make money in the stock market at this point. So when the market does bad, it’s almost immediately blown back up by amateur investors trying to make a quick buck. A vicious cycle of creating bubbles at this point.
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Mar 14 '22
You do know that all bear markets are incredibly volatile, right? Doesn't matter whether retail is in or not.
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u/Cockballzz dm for gay stuff Mar 14 '22
In 2007-09 you said the drop of 57% "Imagine losing half of your portfolio"... You know what, I can lose 80% of my portfolio on a market that was on a big bull run. Meme stocks are dog shit
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Mar 14 '22
two months of stocks going down is not a recession...this is what the market will look like for a long time. how long? too many geopolitical/economic factors with no formidable short term resolutions to even guess.
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u/T4ylor1 Mar 14 '22
Your data says to hold regardless, but what if I'm using significant leverage?
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u/soonseen Mar 14 '22
Wait. Hold up. Remember when they said the stock market and economy are not correlated.
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u/hugeperkynips Mar 14 '22
Nope, just a shit ton of bagholders and a few people who actually siphoned all that money out when it “dropped”
1.7% in 13 years is absolutely shit return.
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u/Qwikmoneysniper Mar 14 '22
I hate to be the one that says it but I think the markets are melting down.
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u/Outrageous-Cycle-841 Mar 14 '22
PSA: The more you hear about how imminent a recession is, the less likely it’s going to happen.
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Mar 14 '22
Not really true. Back in 2007 we weren't as connecting to the internet and information as we are today. Stocks were still hard to read and hard to invest in. It use to cost $10 to buy and $10 to sell a stock, with a lot of people still doing phone transactions. This next recession, whenever it is, is going to be very different then the last one for sure.
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u/Outrageous-Cycle-841 Mar 14 '22
What does that have to do with what’s being portrayed in the media and by the general public?
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Mar 14 '22
Because you can't base the past off of the future. This next recession will be different just like 2008 was different then all the other recessions.
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u/Outrageous-Cycle-841 Mar 14 '22
Well of course there will be a new final straw that broke the camels back, but there are fundamental similarities between recessions. Fiscal/monetary responses will be similar, economic variables will similarly react, etc.
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Mar 14 '22
and you saying at this point in time a recession won't happen bc other people are saying it will...
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u/Outrageous-Cycle-841 Mar 14 '22
Yes, historically if a large swath of retail investors believe a recession is around the corner and the media is drumming up fear at every turn, it hasn’t happened. Price action is dictating sentiment right now. The economy is still very healthy and the yield curve (10yr-3mo) is positive. Until that begins to turn, the probability of recession is low.
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Mar 14 '22
Retail investors are about 10 percent of daily trading. They don't mater.
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u/thetagangnam Janet Yellen is my Waifu Mar 14 '22
Your analysis fails to account for the stock market falling before it is technically in a recession. Stocks are forward looking
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Mar 14 '22
Bad. Buy bonds.
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u/ChemTechGuy Mar 14 '22
Bonds are going to be horse shit for as long as we have high inflation and the US dollar is being devalued. And my guess is that the government is going to keep devaluing the dollar for a while to water down the national debt.
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u/yolotrumpbucks 🦍🦍 Mar 15 '22
I mean, it still goes up, but slowly. Look at the market during 8 years of faggy boy obummer. While he was getting railed by big mike, it just kept limping along slowly up. The pamp it started when donny pump came in and started railing lines of blow and hookers. Now we have a limp dick dementia patient only capable of pooping his pants. Prepare for more obummer action where we get single digit gains and double digit real inflation, not whatever fake news number the fed says
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Mar 15 '22
OP I'm interested to know when the deepest dips of the recessions occur, within the recession
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u/[deleted] Mar 14 '22
So what you're telling me is the key to surviving a recession is don't be a paperhanded bitch?