The Investment Scientist

Recession and stock market performance

Posted on: January 25, 2008

What you need to know now the recession is here

Do you ever get that feeling that you’d rather just stay in bed? This morning was one of those mornings. We woke up to the painful news of stock market collapses across Asia and Europe. And then, more surprising, a sudden action by the Fed cutting the interest rate by three-quarters of a percentage point (75 basis points). We never know for sure whether we’re in a recession until National Bureau of Economic Research (NBER) makes it official. That could take up to six months. But the only conclusion I can draw from the immediacy of reaction from the Fed is that if we are not in a recession right now, it’s about to happen.

So what can we expect the stock market to do during a recession-and after it? I may not have a crystal ball to see the future, but I have made an in-depth study of all nine recessions since 1950. Even if history won’t repeat itself, looking at the past half-century should give us some perspective.

Things look gloomy now, but the future is not

How long does the average recession last?

Since 1950, a typical recession lasted for ten months. The shortest one lasted for six months and the longest one lasted for 16 months. (See column 2, Table 1 below.)

What have been typical returns during past nine recessions?

Five of the nine recessions saw the S&P 500 index increased during the downturn (See column 3, Table 1 below). The average index return during recessions was 3.14%.

One year into the start of a recession, the S&P 500 index, on average, increased an anemic 2.95%. (See column4, Table 1.) Yet there are only three instances during this period when the index dropped, and the largest of these was by a painful 27%. However, the remaining six first-year periods saw the index increase. The best of these was by 25%.

By the third year of the start of a recession, the S&P 500 index on average increased 28%, which is slightly below the normal rate of return for the index. There was only one instance when the index was below the start of the recession. (See column 5, Table 1.)

Ten years into the start of a recession, the S&P 500 index on average increased 139.6%. There were no instances of the index being below the start of such a long recession. It’s worth noting 139.6% for ten years is still below the normal rate of return for the S&P 500 index. (See column 6, Table1.)

Table 1: S&P 500 returns during and after recessions

Recessions # of months During R 1 year 3 year 10 year
Jul 1953 – May 1954 10 17.94% 25% 100% 179%
Aug 1957 – Apr1958 8 -3.94% 6% 26% 107%
Apri1960 – Feb 1961 10 16.68% 20% 28% 50%
Dec 1969 – Nov 1970 12 -5.28% 0% 28% 17%
Nov 1973 – Mar 1975 16 -13.13% -27% 6% 73%
Jan 1980 – Jul 1980 6 6.58% 13% 27% 188%
Jul 1981 – Nov 1982 16 5.81% -18% 15% 196%
Jul 1990 – Mar 1991 8 5.35% 9% 26% 302%
Mar 2001 – Nov 2001 8 -1.80% -1% -3%
Average 10 3.14% 2.95% 28.20% 139.16%
Current recession started Dec 2007 18 -34.8% -39.2% -9.9% ?

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Small cap value stocks will do better, if history repeats itself

I’ve used the Small-Cap Value Index constructed by Fama and French to study the effect of recession on small cap value stocks for the last nine recessions since 1950.

On average, the Small-Cap Value Index returned 11.39% during a recession. During those recssion periods, the returns of the Small-Cap Value Index ranged from barely dropping (-2.17% in the ’69 recession) to strongly rallying (38% in the ’81 recession). (See column 2, Table 2 below.)

One year into the start of a recession, the index on average returned 13.21% with only one instance of index decrease. (See column 3, Table 2.)

Three years into the start of a recession, the index on average returned 76.21%with 31% being the worst return. (See column 4, Table 2.)

Ten years into the start of a recession, the index on average returned 506.26% with 312% being the worst return and 1183% being the best. (See column 5, Table 2.)

The reason I recommend my long-term approach and staying with small cap value stocks is because of these results.

Table 2: Small cap value returns during and after recessions

Recessions
During R 1 year 3 year 10 year
Jul 1953 – May 1954 10.11% 21% 100% 362%
Aug 1957 – Apr 1958 -0.56% 18% 63% 517%
Apr 1960 – Feb1961 21.72% 32% 46% 343%
Dec1969 – Nov 1970 -2.17% 7% 31% 312%
Nov 1973 – Mar 1975 17.81% -13% 86% 1183%
Jan 1980 – Jul 1980 3.11% 15% 96% 499%
Jul 1981 – Nov1982 38.29% 0% 95% 387%
Jul 1990 – Mar 1991 5.52% 9% 83% 448%
Mar 2001 – Nov 2001 8.68% 31% 86%
Average
11.39% 13.21% 76.21% 506.26%

How shall we learn from history?

We can take the short view. In the last six months, the S&P 500 has dropped more than 15%. The Small-Cap Value Index has dropped more than 25%. Should we conclude that at this rate, all investment in stocks will be lost in two to three years?

Should you panic now?

The answer is no. But that’s precisely what many investors are doing now by taking money out of the market or rotating them to stocks they perceive to be safer. There is a better way to learn from history.

Take the long view

If you want to sleep well while building your wealth for the long term, you must take the long view of history. Then you’ll be more like Warren Buffet and John Bogle who see the current market madness as normal and transitory. William Shakespeare could well have been talking about the emotional turmoil of the market when he wrote,

It’s like a tale told by an idiot, full of sound and fury, but signifying nothing.

Sleep well, take the long view.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

18 Responses to "Recession and stock market performance"

thank you

Guess this one is different than all the other recessions you studied. I noticed the great depression is not in your analysis. It seems that might be a better fit.

“Taking the long view” this time would mean -40% or more returns for the year and negative returns for the past 10 years.

Frankly, I can’t see how we will get out of this with every American family owing more than $90,000 of national debt.

That said, I like your website and your research.

Jim Y.

James,

At the time of research, I left out the Great Depression since it was so distant and the economy was very different. In retrospect, I was wrong – the more things change, the more they stay the same.

Michael

Yes, the current downturn blows this whole table out of the water.

There are so many tables on Investment Scientist showing how Small Value does well after recessions, after the start of bear markets, after FF Rate drops of 200 bps or more, etc.

Yet this present situation just throws all that out of the window.

I totally agree. The current downturn is turning out to be a once-in-a-hundred-year event. It is already a lot worse than anything we’ve seen since the second world war.

The only strategy that might be good now is :

1) HIgh-dividend ETFs
2) Conservative Covered calls on those same ETFs (we don’t want to risk missing the many bear-market rallies, so the covered calls employed should be very conservative).

The good news is that once this is over, we won’t have to worry about a similar situation again in our lifetimes.

I wrote about these two points as well. By then it was clear this is not a garden variety recession:

1) Dividends to the rescue in a Great Depression
2) How to transfer returns from bull markets to bear markets

Also, I put together a complete list of high-dividend-yield ETFs.

Needless to say, we see eye to eye on this.

I believe that dividend stocks have an important niche in anyones portfolio. Doing a study of these particular stocks from the 90″s show reasonable growth and good dividends for a select few. They have weathered two recessions and are performing as well if not better than the markets.

Ray,

You made a great observation. Check our my research on this subject …

https://investment-fiduciary.com/about/dividend-to-rescue-in-a-great-depression/

However, dividend stocks are tax-disadvantaged and they usually don’t perform well in an inflationary situation.

[…] and moved their clients’ money into cash before sh*t hit the fan. I am not one of them. Though I did see storm clouds gathering, I underestimated the severity and stuck with their original investment plans through the […]

its a wonderful thing to do

[…] and moved their clients’ money into cash before sh*t hit the fan. I am not one of them. Though I did see storm clouds gathering, I underestimated the severity and stuck with their original investment plans through the […]

Thanks for your insight. What source did you use for the Small Cap Value returns?

Doug,

I used Prof Kenneth French’s data library. If you google “Ken French”, you will get the link to his data library in the first ranking.

Michael

Michael,

Thanks for the information. I was trying to recreate your figures and was having trouble. I noticed there are a number of small cap value portfolios listed on the French’s website and wasn’t sure which data set you used. If you can provide me with a little more guidance that would be helpful!

Thanks,
Doug

Michael…this is interesting data and since we are nearly three years from the end of the previous recession, can you update Small Cap Value at the end of June 2012? Thx.

simply awesome!!! bookmarked

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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