The Investment Scientist

Recession Stock Market Performance Revisited

Posted on: February 18, 2011

Recession Stock Market

Three years ago, at the onset of the recession, I performed research analyzing the previous nine recessions after WWII and wrote an article “Recession and Stock Market Performance” based on that research.

Given that I am not clairvoyant – unlike many market pundits and some fellow financial advisors – I can’t see the future. I can only use my research of the past to frame my perspective of the future.

I came away with two conclusions:

1. The future for the stock market is not gloomy.

2. Small cap value will likely perform better.

I further exhorted investors not to panic and take a long view. Well, three years have passed since I wrote that article. It’s time for reflection.

The recession was a lot worse than the previous nine recessions I researched. It lasted 18 months; the longest recession previously was only 16 month. It caused the S&P 500 to drop 39% within a year; previously, the worst was a drop of 27%. Three years later, the index is still down 9.9%; previously, the worst three year return was down 3%. Despite that, I was largely on the money.

Small cap value did a lot better during and after the recession, as the table below shows. Based on the Fama/French data, the small cap value category of stocks returned 17.7% three years after the start of the recession. That’s a lot better than the -9.9% return of the S&P 500, a large cap index.

During Recession One Year Later Three Years Later
Time Period 12/2007 – 6/2009 12/2007 – 12/2008 12/2007 – 12/2010
S&P 500 -34.8% -39.2% -9.9%
Fama/French Small Value -33.6% -31.8% 17.7%
70/30 model portfolio -27.6% -24.1% 11.3%
60/40 model portfolio -24.8% -18.4% 14.5%
50/50 model portfolio -20.5% -15.5% 14.5%
40/60 model portfolio -16.4% -11.3% 14.3%

I remember at the time that pundits were telling investors to rotate to “large cap quality stocks.” Those pundits apparently knew the future so well that they didn’t need to know the past: not once in previous recessions did large cap outperform small cap value.

My exhortation not to panic but to take the long view was also correct. A simple-minded buy-and-take-a-vacation-in-Mars investor would have come back to see his equity portfolio largely unchanged. Not good, but by no means a disaster. A disciplined allocate-and-rebalance investor would have seen better returns with much reduced risk. (See model portfolios in the table.) The disaster was reserved for those “smart” investors who thought they could predict the future.

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2 Responses to "Recession Stock Market Performance Revisited"

Points well made. I especially like the quote “Those pundits apparently knew the future so well that they didn’t need to know the past”. Research like this is very valuable for do-it-yourself investors – especially those who haven’t been through a downturn before.

DIY Investor,

I have found doing the research very helpful to my work as well. As a financial advisor, I am swept by the same tides of emotion (greed or fear) that sweep the market. Doing research helps ground my decision.

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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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