Stock Market Performance During Recessions

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Stumbled across another interesting chart from Fidelity Investments showing stock market performance during and after previous recessions:

Found via the Financial Philosopher, who stated:

Now that we are “officially” in a Recession, what does that mean for stocks going forward?

Of course, no one really knows the answer to that question, and I certainly will not attempt to do so here. What some of you may not know, however, is that, once the “recession call” is made, stocks have historically been quite close to a significant march upward.

The reason for this is that economists look backward and investors look forward.

I have no idea if this will hold true, but according to the National Bureau of Economic Research, this current recession began in December 2007.

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  1. The best returns almost always follow a down market. If you are investing regularly, you stand to make very good money when the market does return.

    Dollar cost averaging for the win!

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  3. In this past month’s “Money” magazine there was a great article regarding expectations of market returns and the basic concept was that you cannot look at past returns as a historical gage of future returns. Take America for example: from 1900 till now, America was an emerging economy that will not likely be able to repeat that kind of growth in the future, future returns may not average the historical 8-10% but be closer to 5-7% returns. Thank you Justin for posting what percentages would be needed to break even, that is a misconception for a lot of people. They don’t realize a 50% requires a 100% gain to break even.

  4. This recession will be double or triple the length of the average bear market. It is best to stay on the sidelines until the market turns up.

    A 30% loss needs a 43% gain to break even
    A 40% loss needs a 67% gain to break even
    A 50% loss needs a 100% gain to break even
    A 60% loss needs a 150% gain to break even

    Peserve you capital and invest when markets go up, NOT down.

  5. Lots of falling knife catchers out there. The same people saying that rebound is around the corner are the same people who didn’t see this crisis coming. And there are people still buying REITS on dollar cost averaging. Amazing!

  6. Here is a great 2 page article on how coming out of recessions Small/Micro tends to significantly outperform large caps. Oddly, the conventional wisdom during a recession is to run to blue chips, but the evidence indicates that is the wrong move.

    (FYI, I don’t recommend this fund… ridiculous management fee. That said, the article is a good one.)

  7. Justin,

    Thanks for that advice… be sure to let us all know when the markets are going to go up!

    FYI, since the bottom in November, the S&P has rebounded as much as 24%… Do you recommend giving up 24% of return waiting on the sideline until things get “safe”? Fact is, history shows markets do rebound quickly. If you aren’t in the market, the only thing you are guaranteeing is that you are selling low and buying after things get high again.

  8. A lot of the big bounce backs occur while the market is still unstable, if you wait for a definite upward trend you’ve already missed the bottom.

  9. Maury, all you had to do to get that 24% (and it’s only about 15% based on today’s market prices) was take a 46% loss, of which it will take an 87% gain to recover. That’s not a very convincing argument for your side.

  10. I went to cash in December of 2007 and finished up for 2008 (scalping very small trades). You guys are right – bear market rallies are very powerful. There will be periods of time (4-6 weeks) where you can make money (hence my scalping).

    I highly doubt November is ‘the bottom’. I will give up the 24% until things get safe.

    My guess (and this is a guess – only the market is right) is we should head back down to 7,800-7,900 over the next 30-45 days.

  11. Brian,

    The trick is, most people took that 46% loss anyway…

    Now if your saying the right move was to get out before that 46% loss, then yes. I’m thinking everyone wishes they had the foresight to do that. The fact is, nobody really did.

    I guess my point is that if you’ve taken a 46% loss, that is probably the worst possible time to sell, or go to cash waiting for the market to become safe again. (Of course by the time the market feels “safe” again, much of the rebound will have already happened.)

    Justin feels the market still has further to drop, others like Buffett and Grantham think the market is selling at a huge discount. These investors admit things could certainly get worse before they get better as Justin states, but they don’t feel they have the ability to time the market that well. Their thought is to get invested while assets are at historically cheap levels which runs counter to the thought of waiting in cash for things to get better.

  12. I don’t think any of us can really say what the market is going to do. I would guess that it’s bottomed out and is ready to go back up, but I guess that is just wishful thinking and comes from a hope that we’ve seen the worst.

    Fact is, none of us really know when things are going to turn around.

    Loved the graph.

  13. Thanks for the mention in your blog article…

    As most already know, my reference to the Fidelity chart was for observational purposes and not to make a “prediction,” which is a foolish endeavor.

    I must say that the most interesting observations to make are those of human behavior during market extremes.

    The “herd” is right most of the time; however, the times when the herd is most often wrong is at the tops and bottoms of market cycles.

    We’ll see what occurs during 2009.


  14. Maury,

    Whether or not folks took a loss or not (and in my case, yes, I sold 70% of all of my stocks in August 2007 in anticipation of the inevitable post-housing-bubble economic collapse) there is a fallacy that people seem to fall into, and it is that stocks are now “cheap” and therefore it must be a good time to get in. Folks like Buffet and Greenspan completely missed the bubble, which amazes me since even I could see it coming with some simple analysis and calculation of buy-rent ratios and incomes vs. house prices. One might say “a broken watch is right twice a day”… well…. all I can tell you is the incredible excesses of the unsustainable housing boom was obvious to many, even some on this forum. Just as the excesses of budget deficits, medicare, pensions, state governments, SS… what is going to happen in the not-too-distant future with these huge liabilities? They are unprecedented in the history of this country. To expect that they’ll magically be fixed in some far-off future time, and 10% per year stock appreciation will return and continue forever, just like folks seemed to ignore the fact that no one could afford houses that appreciate 10% per year, yet expected theirs to make them a millionaire so they could retire at 50.

    But back to the original point, by what measure are stocks cheap? By trailing p-e they are cheap, but that is irrelevant, because all that matters are future earnings. In the 1930s earning were dismal and stocks declined a total of 89%, and it took a world war and the unprecedented position which the US found itself in following its victory to enable the growth out of the depression. Profits are all that matter in the stock market. If earnings are cut in half from 2008 then S&P should be cut in half as well, as it has. Earnings outlook won’t be good either, but we’ll find out as companies report throughout 2009 whether or not the S&P is truly “cheap” at least based on their 2009 earnings. We might well find that the S&P still has a P/E of 20 with its lower earnings.

    This doesn’t mean it will decline more or less, but it doesn’t indicate that it is “cheap” and a screaming buy. It is, more than likely, fairly priced. So to purchase fairly priced equities right now means you believe that the economy will be growing soon. Unfortunately, this is is a pure gamble due to the constant and unprecedented government intervention. The gov’t hasn’t exactly been a shining star lately, and central planning does not bode well for economic growth in the future for a country that is based on free markets. Hopefully we will stop begging the gov’t for handouts and get back to actually creating real wealth in this country!

    I guarantee you, if the S&P looks cheap based on actual earnings then I’ll be first in line to buy some shares! But Japanese stocks looked really cheap in the early 1990s, and yet they kept getting “cheaper”. They had ZIRP and they tried to rescue their zombie banks, just like the US, to no avail.

  15. I love how people don’t think you can time the market. You can! Successful investors do it all the time – if fact there is a very well know publication that does it. Investors Business Daily!

    I would also like to add Buffett bought Goldman Sachs at $120. Todays closing price was $78. That is about a 35% loss. He also did a deal with GE at $23, today GE closed at $15. This would be a loss of 35% as well.

    Also, Brian is very right –

    “It is one of the great paradoxes of the stock market that what seems too high usually goes higher and what seems too low usually goes lower.” – William O’Neil

  16. I would humbly suggest that the proper and prudent question to ask is not, “Where will stock prices be one year from now?”

    Anyone using stocks for a 12-month investing objective is using an improper tool for the particular purpose.

    I would propose a different, yet very simple question that may bring up different answers: “Which asset class (stocks, bonds or cash) is most likely to provide the greatest return over the next 36-month period?”

    “If we will be quiet and ready enough, we shall find compensation in every disappointment.” ~ Henry David Thoreau

  17. Yes you can time the market – hell – this market has traded between 8 and 9k HOW MANY TIMES in the past 6 months? It’s predictible as clockwork.

    Wait, no, just buy and hold … LOL. That’s not a strategy – that called LAZYNESS or better yet IGNORANCE.

    Anyone think BOA is a buy now @ 10?

  18. I wish the market stays low and gets even lower for a few years. I know a that means more misery in the short term but in the long run that means I buy a lot of stocks on the cheap now and and get the rewards in retirement.

  19. I hate to sound like a broken record, but where’s the inflation adjustment?

    Inflation, measured by CPI, from January 1980 to December 1982 was 25%+ (for the period, not annualized). So you “went nowhere” being invested in that period. Even though the market “recovered” and your stocks were worth more dollars, those dollars didn’t buy anything more in January 1983 than they did in December 1979.

    Another example with the S&P 500 (chart):
    Jan, 2000: 1460
    Oct, 2002: ~800 (10-year low)
    Oct, 2007: 1500+ (10-year high)
    Jan, 2008: ~1400
    Nov, 2008: ~800 (10-year low)

    Inflation from Jan 2000 to Jan 2008 (from here): 25%.

    So from high points to high points (say Jan 2000 to Jan 2008), the average S&P investor has been losing purchasing power. Even from low point to high point, the annualized real returns aren’t that great (~8%). Even if you had near perfect timing on the S&P, you made maybe 8% in real gains from 2002 to 2007 (not including taxes).

    Now here’s the bigger problem.

    Let’s say this is the bottom. Let’s say the market does nothing but go up 10% / year for the next 10 years. Does that really mean we’ve made the right call?

    Obama just promised to “print” another trillion dollars next year. That’s $1,000,000,000,000. That’s the estimated GDP of Canada (at current conversion rates). Obama is planning to “print” a Canada in 2009. The US just “printed” a trillion dollars in 2008 and it’s going to happen again. Obama is dedicated to printing that much money for years to come if he needs to.

    Here’s the problem, more money in circulation = more inflation. We’re in a deflationary bubble right now, b/c lots of money just “disappeared” in all of these bankruptcies and crises. But it won’t last for very long. At the end of the tunnel making 10% / year on the S&P for the next 10 years probably won’t mean a thing, b/c it won’t buy any more loaves of bread in 2019 than it did in 2009.

    Just like nobody really “made money” in 1980 to 1982 (despite the 25% nominal jump).

    Please be aware of this when you are investing. The fact that the S&P has hit a low may not make any real difference in the next decade. If the stock market doesn’t hit multiple new highs you’re losing purchasing power. In fact, even if the market does hit new highs you could be losing purchasing power.

  20. Just to remind you, if you buy mutual funds thinking the market will go down that day, you’re getting hammered because most of the up action is happening at the end of the session. That means that mutual fund investors are buying at the highest of the session, since your buy orders come at the end only. If you have paid attention for the last year, the last 30 minutes of the session is usually when that market is at its highest, so there come your brokerage firm with your buy orders right at the peak of the session. ETF investors can buy anytime, and still have stop limits available.

  21. Probability wise, this isn’t such a good trade to make. The chances are only 6/14 (3/7) you will win, your maximum theoretical risk is 76.9%, your maximum theoretical gain is 41.1%.

    Just another way to look at the numbers.

  22. If you have money that you would not need for the next 3-5 years, you can probably start investing in the stock market now. But make sure that this is only a small portion of your available cash. An emergency fund should be always within reach before stock investing as a general rule.

  23. @Bernz: What makes you think that investment gains over the next 5 years will outpace inflation and preserve or increase capital?

    Unless you plan on investing in “other people’s” stock markets (i.e.: non-US markets) I don’t see how the US companies are going to help you maintain your buying power.

    At best you might get a couple of “blue chips” floating along, but your plan does nothing to mitigate the massive inflation risk that’s currently abounding.

  24. Johny Stockton says

    I said it before and i`ll say it again. You cannot tell from year to year what direction the market will go. You do however know when the market surges from year to year or gets hammered. Therfore, all you need to do is what I said before. Very simply put, buy low and sell high. So if the market goes up 48% in 2 years then you better sell! Then sit on the sidelines in a safety account until prices go down. Might take a couple of years but it will happen! Meantime if market goes up while you are in cash, so what. You have to know how to hedge a bit to be “safer” and actually make some money. I sleep very well with this strategy. BTW, yes I did sell last year before the big drop. I`ve been adding money into the market since March. I`m making money while everyone else is feeling pain. Dummest thing people do is buy when things are up and panic sell when it goes down!

  25. Justin – I think you got lucky selling when you did. Don’t make the mistake of taking credit for your luck and thinking your “acumen” will persist. Your implication that you make better investment choices than Warren Buffet should be a strong warning sign to yourself if you are thinking clearly.

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