What Happens to the Stock Market After a Recession?

The S&P 500 is down more than 20% from where we started the year. It seems like every day, more and more people are hopping off the bullish case for a economic soft-landing, most recently (and perhaps most significantly) Fed Chair Jerome Powell. The Fed has been on a rate hike campaign all year, and there are promises of two more rate hikes before the year ends. Last night I was doing everything I could to convince my 2 year old daughter to take her cold medicine. She was kicking and screaming but she eventually took it. The market behaved similarly yesterday during Powell’s press conference. Inflation is the illness, and rate hikes are the medicine.

If a soft landing is off the table, there are a few questions to consider. How deep of a recession are we going to see? How long will it last? With the stock market down more than 20% year-to-date, and 10% in the last month, how much of pending recession has already been priced into stock prices? Is there still more room to fall, or have we seen an over-correction to the downside?

I could end the post here with a simple (but honest) answer of “no one knows for sure” but that wouldn’t be too productive. Rather, let’s use history as a guide. The stock market can’t be predicted any more than I can predict whether or not my daughter will eat her dinner tonight. Historical market returns can’t be used to predict future market returns. But we can look at overall market behavior in past recessions, and subsequently following those recessions, and hopefully gain some useful perspective.

One of my favorite writers on the stock market and the economy is Ben Carlson. Ben is the Director of Institutional Asset Management at Ritholtz Wealth Management and has an investing blog that I’ve read for a while. A few years ago he wrote a piece about historical recessions and the impact on stock prices. He studied all economic recessions going back to the end of World War II, and found that the average performance of the S&P 500 during a recession was 3.8%. Certainly there are examples where the stock market tanked during a recession, like the Great Recession in which the market fell by 35%, but of the 12 recessions between 1945 and 2020, 7 experienced positive returns in the market.

He also studied peak-to-trough drawdowns in the market during recessions, and found that with the exception of one time (in 1945), every recession had a drawdown in the S&P 500 of at least 10%, and 75% of the time the market fell by 20% or more. What I found most useful was the study he did on the performance of the stock market following the end of a recession. In 10 out of 12 times, the market had positive returns in the one-year following the end of a recession, with the average return being 15%. In every single 3-year and 5-year period following the end of a recession, the market was positive, with average returns of 45% and 120%, respectively.

Every recession and market environment is different, and the current environment we find ourselves in is certainly no exception. We’re constantly seeing things happen both in the stock market and the economy that have never happened before. If there’s anything to take away from this, I suppose it’s to not get caught up being unable to see the forest through the trees. 

Professional asset managers like hedge funds are beholden to their investors, and they’re only ever as good as the returns on their last quarterly statement. They need to be nimble, making constant portfolio decisions and being able to justify those decisions to survive and keep a job. Their advantage is technology, experience, education, and money. As individual investors, you can’t compete with those things, and you shouldn’t try. But there is at least one area where you do have a leg up on Wall Street - time. You don’t have a board of directors to answer to. You can afford to stick to a long-term plan, to not make rash decisions, and to play the long game. And while sticking to your guns and weathering the storm is a lot more difficult that it sounds like when you look outside and see dark clouds, it’s a strategy with a pretty darn good track record.