During a recession, stock prices frequently fall. In theory, this is bad news for a current portfolio, but leaving investments alone means not selling to lock in recession-related losses.
Furthermore, decreased stock prices provide a great opportunity to invest for a reasonable price (relatively speaking). As a result, investing during a downturn can be a good decision, but only if the following conditions are met:
Is it possible for the stock market to rise during a recession?
The graphic above (which only includes recessions from the 1950s as given by NBER) has many major takeaways:
- Length. Since 1953, the average length of a recession has been 10.3 months. The Covid recession lasted barely two months, while the Great Financial Crisis of 2008 lasted nearly twice as long.
- Prior to and during economic downturns. The S&P 500’s cumulative price return was lowest in the year leading up to a recession (-3%), followed by six months before (-2%), compared to an average loss of 1% during a recession. Furthermore, approximately half of the time, returns were positive across all three periods. Markets look ahead, whereas economic data looks back.
- After a downturn. It should come as no surprise that as time passes following a recession, cumulative returns become increasingly positive. Stocks, after all, tend to go up rather than down. And the longer you invest, the less likely it is that you will lose money. Positive returns approximately double in frequency.
- Every time is unique. History is a valuable resource, but it cannot be used to foretell the future. The 1980 recession ended a year before the beginning of the 1981 recession. The ramifications can be seen in the graphs above. Similarly, the Great Recession of 2008-2009 was by far the worst for stocks during a downturn, and the outperformance one year after the Covid fall was an exception as well. Despite the year-to-date decline, the S&P 500 has gained more than 59 percent since the conclusion of the 2020 recession in May 2020 (almost 64 percent if dividends are included!). 1
In a recession, does the stock market fall?
How can you figure out if a recession is already factored into the S&P 500? Or how much would stock prices fall if there was one? It’s based on earnings from the S&P 500.
According to Colas, the S&P 500’s earnings have declined by an average of 30% in the five profit recessions since 1989. Recessions were responsible for four of the reductions. What does this mean for the S&P 500 today? The index’s companies just reported a $55-per-share profit in the fourth quarter. According to Colas, this equates to $220 in “peak” earnings power per year.
That indicates that if the economy tanks, the S&P 500’s profit will certainly plummet by 30% to $154 per share. The S&P 500 earned exactly that in 2019, when it traded for 3,000 by mid-year. This offers you a market multiple of 19.5 times, which is reasonable. In a recession, if investors are only prepared to pay roughly 20 times earnings, the S&P 500 drops to 3,080, or a 28 percent loss, according to Colas.
“We’re not predicting a decline in the S&P to 3,080. The objective here is to highlight that, despite recent turbulence, large-cap stocks in the United States still predict 2022 to be a good year “he stated
In a recession, how much value does the stock market typically lose?
Most investors are unnerved by economic crises, market falls, and excessive market volatility. High levels of uncertainty and fear, on the other hand, might lead to fantastic investment possibilities.
The fiscal tightening and Vietnam War; the Nifty Fifty boom and oil crisis; the Iran oil crisis and Volcker monetary policy tightening; the early 1990s monetary policy tightening; the IT bubble; and the global financial crisis are the six US bear markets we examine. A shock to fundamentals was the key cause for four of the six market and economic downturns: fiscal tightening and the Vietnam War, the Iran oil crisis, early 1990s monetary policy tightening, and the global financial crisis. The triggers, or at least significant component catalysts, of the two remaining bear marketsthe Nifty Fifty and the tech bubbleare bubbles that are about to burst, in our opinion. 3 Despite the lack of established rules for diagnosing bubbles,4 these two periods are usually referred to as bubbles in the investment literature. 5
Importantly, labeling these two periods as bubbles does not mean that equity markets were overvalued as a whole, but rather that only particular market segments were inflated. We empirically observe much wider-than-average pre-crisis valuegrowth valuation dispersions in both periods (we will present these statistics later), which may have foreshadowed some level of irrational optimism about specific stock cohorts. The commencement of the bear market in both cases coincided with the narrowing of the valuation spread. This is what we interpret as the bubble bursting. The more expensively valued stock cohorts did not rebound to their pre-crisis levels in either crises. 6
The S&P 500 Index fell by 32 percent on average from the market high to the market bottom in the six market downturns we looked at. During these time periods, the two value strategies in our study outperformed by 12% on average. Value strategies outperformed the market by roughly 34% on average from the market peak to bottom when the market fall was preceded by (and partly driven by) the burst of an asset bubble and, characteristically, by a broad dispersion in valuegrowth valuations. When the loss was primarily due to a fundamental shock, value stocks were affected harder, similar to what we saw in the first quarter of 2020’s bear market. Despite the current period’s enormous value dispersion, unlike the Nifty Fifty and the tech booms, the current crisis is not associated with the bursting of a bubble.
Value beat the market in five of the six recoveries we looked at, each time by double digits; the average cumulative outperformance was 24 percent. The only time value underperformed in the recovery was from 1970 to 1972, which coincided with the build-up to the Nifty Fifty bubble. When the Nifty Fifty bubble broke, value beat growth by a wide margin, not just in the down market but during the whole downturnrecovery cycle.
Low volatility, quality, and size techniques, sometimes known as factor investing or smart beta, have been gaining popularity and accumulating assets at a rapid rate. These tactics, too, can bring both obstacles and opportunity in tumultuous times like the ones we’re in now. Low volatility strategies, on the other hand, show a more subdued decrease in bear markets and a slower recovery in market recoveries than other strategies.
Other than value, the low volatility portfolio had the best overall performance of the four systematic methods throughout the complete cycle. Following downturn markets, quality portfolios have a small outperformance on average, but huge outperformance during recoveries. Small-cap strategies perform poorly during market declines but outperform dramatically after market recoveries. Finally, cross-sectional momentum strategies tend to underperform in both bear and bull markets.
Before the market crashes, where should I deposit my money?
The best way to protect yourself from a market meltdown is to invest in a varied portfolio of stocks, bonds, and other asset classes. You may reduce the impact of assets falling in value by spreading your money across a number of asset classes, company sizes, and regions. This also increases your chances of holding assets that rise in value. When the stock market falls, other assets usually rise to compensate for the losses.
Bet on Basics: Consumer cyclicals and essentials
Consumer cyclicals occur when the economy begins to weaken and consumers continue to buy critical products and services. They still go to the doctor, pay their bills, and shop for groceries and toiletries at the supermarket. While some industries may suffer along with the rest of the market, their losses are usually less severe. Furthermore, many of these companies pay out high dividends, which can help offset a drop in stock prices.
Boost Your Wealth’s Stability: Cash and Equivalents
When the market corrects, cash reigns supreme. You won’t lose value as the market falls as long as inflation stays low and you’ll be able to take advantage of deals before they rebound. Just keep in mind that interest rates are near all-time lows, and inflation depreciates cash, so you don’t want to keep your money in cash for too long. To earn the best interest rates, consider investing in a money market fund or a high-yield savings account.
Go for Safety: Government Bonds
Investing in US Treasury notes yields high returns on low-risk investments. The federal government has never missed a payment, despite coming close in the past. As investors get concerned about other segments of the market, Treasuries give stability. Consider placing some of your money into Treasury Inflation-Protected Securities now that inflation is at generational highs and interest rates are approaching all-time lows. After a year, they provide significant returns and liquidity. Don’t forget about Series I Savings Bonds.
Go for Gold, or Other Precious Metals
Gold is seen as a store of value, and demand for the precious metal rises during times of uncertainty. Other precious metals have similar properties and may be more appealing. Physical precious metals can be purchased and held by investors, but storage and insurance costs may apply. Precious metal funds and ETFs, options, futures, and mining corporations are among the other investing choices.
Lock in Guaranteed Returns
The issuers of annuities and bank certificates of deposit (CDs) guarantee their returns. Fixed-rate, variable-rate, and equity-indexed annuities are only some of the options. CDs pay a fixed rate of interest for a set period of time, usually between 30 days and five years. When the CD expires, you have the option of taking the money out without penalty or reinvesting it at current rates. If you need to access your money, both annuities and CDs are liquid, although you will usually be charged a fee if you withdraw before the maturity date.
Invest in Real Estate
Even when the stock market is in freefall, real estate provides a tangible asset that can generate positive returns. Property owners might profit by flipping homes or purchasing properties to rent out. Consider real estate investment trusts, real estate funds, tax liens, or mortgage notes if you don’t want the obligation of owning a specific property.
Convert Traditional IRAs to Roth IRAs
In a market fall, the cost of converting traditional IRA funds to Roth IRA funds, which is a taxable event, is drastically lowered. In other words, if you’ve been putting off a conversion because of the upfront taxes you’ll have to pay, a market crash or bear market could make it much less expensive.
Roll the Dice: Profit off the Downturn
A put option allows investors to bet against a company’s or index’s future performance. It allows the owner of an option contract the ability to sell at a certain price at any time prior to a specified date. Put options are a terrific way to protect against market falls, but they do come with some risk, as do all investments.
Use the Tax Code Tactically
When making modifications to your portfolio to shield yourself from a market crash, it’s important to understand how those changes will affect your taxes. Selling an investment could result in a tax burden so big that it causes more issues than it solves. In a market crash, bear market, or even a downturn, tax-loss harvesting can be a prudent strategy.
In a downturn, how do you make money?
During a recession, you might be tempted to sell all of your investments, but experts advise against doing so. When the rest of the economy is fragile, there are usually a few sectors that continue to grow and provide investors with consistent returns.
Consider investing in the healthcare, utilities, and consumer goods sectors if you wish to protect yourself in part with equities during a recession. Regardless of the health of the economy, people will continue to spend money on medical care, household items, electricity, and food. As a result, during busts, these stocks tend to fare well (and underperform during booms).
How long do most recessions last?
A recession is a long-term economic downturn that affects a large number of people. A depression is a longer-term, more severe slump. Since 1854, there have been 33 recessions. 1 Recessions have lasted an average of 11 months since 1945.
Do value stocks perform better during a downturn?
During bear markets and economic recessions, for example, value stocks outperform, whereas growth stocks outperform during bull markets and periods of economic prosperity. Short-term investors and those attempting to time the markets should take this element into account.