Stock Market Performance During Recessions

Common Wisdom often suggests that the US Stock Market indices go down during a US recession. How true is this?

According to National Bureau of Economic Research (NBER), there have been nine Recessions (*) from 1950 to 2007.



The S&P 500 Stock Market return during these nine recessions has averaged -0.4% with a low of -22.9% (1973 to 1975) to a high of +16.4% (1953 to 1954).

If we look at the return of the S&P 500 six months before the Start of the Recession to the Peak, the S&P 500 during this period returned an average of -3.7%.

If we look at the return of the S&P 500 six months before the Start of the Recession to the Trough, the S&P 500 during this period returned an average of -4.1%.

Any Positives?

The S&P 500 during US Economic Recession from 1950 to 2007 has been mildly flat to down, confirming common wisdom. However, we can take some positives from the data.

The average ratio between the length of time of an Expansion to the length of time of a Contraction, is 6.7. This means that for every month the US market contracts, (during this particular 1950 to 2007 period) the US market expands 6.7 months.

The S&P 500 return from Previous Trough to Current Trough (8 entries from 1950 to 2007) averages a whopping 80%. If we annualize this per year, the stock market S&P 500 returned 11.7% during expansion phase from 1950 to 2007.

(*) Definition of Recession According to NBER

According to NBER:

The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. For more information, see the latest announcement on how the NBER's Business Cycle Dating Committee chooses turning points in the Economy and its latest memo, dated 07/17/03.

Other Views of Stock Market Returns during US Recession

New York Sun Article.

MarketWatch's Mark Hulbert Article.

BestWayToInvest Article

S&P 500 Index Values used in Research

The NBER Cycle link only provides the month start and end of a Recession. S&P 500 prices were sampled at the first day of the month mentioned by NBER.

Historical S&P 500 PE Ratios and Earnings (Aug. 15, 2007)

From 1988 to August 15, 2007, the average trailing Price to Earnings (PE) ratio of the S&P 500 was 22.7. As of August 15, 2007, the current trailing PE ratio of the S&P 500 is 16.3.

Since we are using the years 1988 to 2007, this overweights the great bull market of 2000 including the Bubble. According to Wikipedia, the average PE ratio of US Equity from 1900 to 2005 is 14 or 16 depending on how you calculate it.



When we look at quarterly earnings (as reported), we notice that earnings from 1988 to the peak of the bubble rose 3 times. From 2003 to 2007, earnings of the S&P 500 rose 5 times!

Yet, if we look at the historical PE, the S&P 500 PE is still a very reasonable 16, and if we look at forward (estimated) PE as of August 15, when the $SPX was 1406, we notice that the S&P 500 forward PE is a low 14.75. This would suggest that the S&P 500 has room to run.

At the moment, the Fed is likely to cut rates. In a falling rate environment, PE ratios can have even more room to expand.

There are also models which look at the yield on the ten year bond to estimate the PE ratio of the S&P 500.

The Ten Year Treasury Bond Yield ($TNX. Divide $TNX by 1000 to get Yield) is currently (August 24, 2007) 4.63%. To estimate the potential PE ratio based on that, we take the reciprocal of the yield, to get 1/.0463 = 21.6.

A low inflation rate is also good for stocks.

Based on all this, the S&P 500 may have room to run to the upside.

Latest S&P 500 estimates from Standard and Poors