Thursday, January 01, 2009

Recessions and stock market performance

[1/1/09] To better understand how recessions typically work, note these four important trends:

1. On average, the S&P 500 has started to lose ground approximately seven months before recessions began.
2. Recessions have lasted an average of 10 months.
3. On average, the stock market has started to recover six months into the recession or four months before it ended.
4. It took approximately 13 months for the stock market to traverse from its peak to its trough.

These averages might not apply to the current recession, but we believe there's a strong chance that some trends could repeat. For example, the stock market could anticipate the beginning and end of the recession before the economic data reflects it.

[6/3/08] Ned Davis Research (NDR), an investment research firm, recently analyzed market performance before, during, and after the 10 recessions since 1945. These have had a median duration of about 10 months. The stock market has generally been a good indicator of these economic slumps.

In past recessions, the broad market began declining several months beforehand, as investors anticipated weaker corporate profits, and continued to drop over the five to six months after the start of the recession, the NDR study shows. From pre-recession bull market peak to recession low, the S&P 500 Index of large-cap stocks fell an average of 23.6%, NDR calculates.

But just as the stock market has anticipated economic downturns, it also has looked ahead to the economic recovery and an earnings rebound. The market historically began rising about midway through these past recessions. On average, the S&P 500 gained 24% six months after reaching a recession low and skyrocketed an average of 32% a year after the recession low.

However, it has taken an average of 20 months for the index to recover to its pre-recession peak after hitting its recession low. (It took the index more than five years, though, to recover from the severe 1973–74 and 2000–2002 bear markets, both of which were accompanied by recessions.)

NDR observes that each of the 10 postwar recessions was accompanied by a bear market, as defined by the firm. In each of these cases, the stock market’s low during the recession was also the bottom of the bear market. (Unlike recessions, there is no official definition of a bear market. The firm notes that 10 of the past 18 bear markets were accompanied by a recession.)

Small-cap stocks tend to underperform those of larger companies leading into and during the early stage of a recession. However, NDR says, just as the S&P 500 Index starts its recovery about six months into a recession on average, small-cap stocks tend to significantly begin outperforming large-cap stocks at about the same time and typically continue leading for at least a year after the recession has ended. For the 12-month period following the end of the last nine recessions, small-cap stocks on average provided a 24% gain compared with 17.6% for the S&P 500.

In terms of market sectors during recessions, NDR found that health care and consumer staples (such as food, household products, and beverage firms) were the bestperforming sectors on average six and 12 months after the start of the last five recessions, dating back to 1973. In fact, health care led in each of these five recessions.

-- T. Rowe Price Report, Spring 2008

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