How Painful Can a Recession Be for American Stocks?

Investors are currently experiencing the 12th bear market of American stocks in modern financial history, if counted from the establishment of the most important index S&P 500.

The current bear market, which officially begins when the leading stock index falls by more than 20 percent from its last peak, is triggered by investor concerns about the slowing growth of the American economy, which is simultaneously facing historically high inflation and an increasingly aggressive policy from the Federal Reserve aimed at reducing inflation.

Compared to the last peak of the S&P 500, which was 4,796 points recorded on the first trading day of this year, the index has plunged over 20 percent, touching a new low at 3,667 points on June 16. As of that date, the losses of the index, which represents the movement of around five hundred key American companies, reached 23.5 percent.

Such losses for a broad range of stocks also affect investor sentiment outside of American exchanges, leading to similar losses in stocks worldwide, which increases investor interest in the further course of this unpleasant period. Given that no one can predict the future with certainty, information about past bear markets can be useful in shaping expectations.

Since 1950, there have been 11 phases of bear markets for the S&P 500 index, as shown in the table below with their most significant characteristics. Here are the key conclusions.

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After the onset of a bear market, it is common for the index to continue to decline before reaching the bottom of the cycle, with the median drop from peak to trough during observed bear markets being -34%.

The intensity and duration of the bear market significantly depended on whether the economy was hit by a recession in the next 12 months (highlighted in red in the table) or not. In 4 cases (1962, 1966, 1987, and the recent 2018), bear markets were not followed by a recession, thus lasting shorter (from 3 to 8 months), and the median performance of the index in the 6 months following the start of the bear market was solidly positive, +16%.

In the other 7 cases (1970, 1973, 1981, 1990, 2001, 2008, and the pandemic-affected 2020) when a recession occurred, bear markets lasted on average 15 months, or 18 months if excluding the very short but intense decline during the pandemic. Additionally, the median market return in the 6 months following the start of the bear market was a decline of -7%.

Given this data, it is of utmost importance whether the Fed can rein in inflation without pushing the American economy into a concrete recession, a scenario that market participants refer to as a “soft landing.” At this moment, there is no consensus among economists regarding such an outcome, and the odds of a recession are at a 50:50 ratio. The latest messages from the head of the Fed, Jerome Powell, are not encouraging either, as he confirmed that the American central bank is firmly determined to curb inflation, but that this could lead to a recession in the American economy.

This uncertainty is also reflected in the volatile movement of stock prices since the beginning of the year, as evidenced by the fact that the S&P 500 index has had daily changes greater than 2% in 20% of trading days since the start of the year. Thus, it is not surprising that the chart of this year’s index movement increasingly resembles a death spiral.

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Source: Bloomberg, FIMA Securities d.o.o.

However, if one can rely on the statistics of previous bear markets, returns in the market one year after the official start of a bear market are most often positive. There are opportunities for those who are adept at taking advantage of rapid market volatility, as well as for those patient enough to wait for the end of this, yet another, bear market.

DISCLAIMER:

The content of this article does not constitute investment advice nor should it be interpreted as a recommendation to buy or sell or a solicitation to buy or sell any financial instrument or group of instruments mentioned herein. All information presented in this article is for informational purposes only. Before trading any financial instrument, it is important to consider the risks associated with investing in them. Trading stocks, ETFs, and other financial instruments involves high risk, and there is a possibility of losing part or all of the invested amount. Past returns of financial instruments are not a guarantee of future returns.