Factoring Out 2008
While I’m not suggesting that you should ignore any of the data, it’s interesting to note that if we limited our look back to only recessions that occurred from 1945-2007, omitting the most recent recession and longest recession, there’s a much more favorable picture for stocks.
During those 11 recessions, the average total return for the S&P 500 was 7.4 percent, 2.3 percentage points greater than the return on one-month Treasury bills. Thus, prior to the most recent recession, there was an equity risk premium even during recessions.
One reason for the above results is that the stock market is a leading indicator of economic activity. The punchline of a classic joke is that the market has predicted far more recessions than have actually occurred.
With this concept in mind, we can look at the data for the six-month periods immediately leading up to each recession. In the six months prior to the 12 recessions, the average return to the S&P 500 was 0.0 percent. Thus, on average, even in the six months leading up to a recession, stocks didn’t produce losses. And in six of the 12 periods, the returns were positive.
The worst return was in the six months prior to the recession that began in September 2000, when the S&P 500 produced a loss of 17.8 percent. The best return was in the six months prior to the recession that began in May 1948, when the S&P 500 produced a gain of 9.8 percent.
If we look at the data for the three-month periods prior to the 12 recessions, we find that the average return to the S&P 500 was 0.7 percent, while the average return to the one-month Treasury bill was 1.4 percent. Thus, while the S&P 500 did, on average, provide a positive return in these periods (and it was positive in seven of the 12), there was also, on average, a negative equity risk premium (and it was negative in eight of the 12).
Variables Of Recession
Providing us with further insight on recessions is the 2008 study, “What Happens During Recessions, Crunches and Busts?” International Monetary Fund economists Stijn Claessens, M. Ayhan Kose and Marco Terrones studied the key macroeconomic and financial variables around business and financial cycles for 21 countries belonging to the Organisation for Economic Co-operation and Development during the period from 1960 through 2007.
They analyzed the implications of 122 recessions, 112 credit contraction episodes (including 28 crunches), 114 episodes of house price declines (including 28 busts), 234 episodes of equity price declines (including 58 busts) and their various overlaps. Following are some of their key findings: