RECESSIONS AND THE STOCK MARKET

An economic recession is defined as two consecutive quarters of negative GDP growth. There have been seven recessions in the US economy since 1970. The typical recession lasts about one year. Some have been as long as two years and others have lasted only six months.

When economic growth declines in a recession, people lose their jobs, and the unemployment rate rises. Corporate profits decline which puts downward pressure on stock prices.

The current situation of higher inflation has caused the Federal Reserve to raise interest rates. The Fed is raising interest rates to intentionally slow down economic activity. The Fed thinks that slowing down the economy will reduce inflation. They would like to slow down the economy enough to lower inflation, but they would prefer to do this without sending the economy into a recession. This is the hoped-for soft landing that we have been reading about in the financial press.

The stock market is very concerned about the potential of a recession because recessions always lead to a decline in stock prices for the major stock market indices. It is important to understand the timing of stock market declines in relationship to when recessions begin and end. This graph compares the price of the S&P 500 compared to each of the recessions since 1970. The recessions are indicated by the grey shaded bars in the chart.

Notice where the stock market bottoms in each of these recessions. The stock market always bottoms during or after each recession. In most cases, the stock market bottoms anywhere from the middle of the recession to the end of the recession. The relationship between recessions and the stock market is amazingly consistent – more consistent than most economic indicators.

This is why the stock market is hyper focused on the Fed, inflation, and economic growth. Normally, the stock market would welcome the excellent economic growth just reported for the third quarter of 2023. But analysts are concerned that the Fed will have to raise rates even more and/or keep rates higher for longer to slow down an economy that is this strong.

This doesn’t necessarily mean that we are going to have a recession. But if we do have a recession, most market forecasters think the market will drop another 20% to 25%. There are no guarantees in the stock market, but it is important to be aware of the relationship between recessions and the stock market.

Forecasts and predictions are notoriously inaccurate, so we will stay disciplined and continue to follow our Market Signals indicator.

Happy Investing,

Phil

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