Market behaviours and recessions

Until monetary authorities provide clear guidance about future policy, volatility risks highlight the need for asset diversification in long-term investment portfolios.

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Boipelo Moyo

Boipelo Moyo

Investment Analyst, STANLIB Multi-Strategy

Key takeouts
  • Equity markets have historically experienced significant declines ahead of US economic recessions, peaking on average six to seven months ahead of the recession’s official start, with an average fall in the S&P 500 index of around 26% from peak to trough. The market lows always occurred before the recessions officially end.
  • The S&P 500 index decline leading up to a recession (market peak to a recessions’ official start date) has been 9.8% on average.
  • 2022 (year-to-date) has seen significant index declines from a January peak. The market is potentially pricing in a recession given an increasingly hawkish Fed, slowing growth in China and political volatility from the Russian invasion of Ukraine.
  • Given the historical playbook, without a policy reversal, there could be more weakness still to come for markets.

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Do financial markets lead economies, and therefore recessions?


This is our view. The recent market behaviour and an environment of slowing growth, high inflation, an increasingly hawkish US Federal Reserve and elevated political tensions from the Russia/Ukraine conflict provides an opportune time to demonstrate this.


Recessions are typically characterised by weak economic conditions experienced over two consecutive quarters linked to certain economic data points that are normally published after the economic downturn has started. The National Bureau of Economic Research (NBER) defines a recession as a significant and wide decline in economic activity that goes on for more than a few months. The NBER typically defines an official start and end to recessions. Investors usually receive confirmation of a recession long after it has happened. In fact, the Business Cycle Dating Committee of the NBER announced more than a year later, in a release on 19 July 2021, that the COVID-19 lockdown-induced decline that started in March 2020 and ended in April 2020 was indeed a recession, the shortest recession recorded by the NBER and shorter than the 10-month average since the recession of 1958.


Periods of economic downturns, reduced consumer spending, revenue and margin compression and elevated credit risks make for an unpleasant equity investment climate. Equity markets try to look ahead to anticipate recessions before they happen, pricing in the impact of a weaker environment. Our analysis aims to look at how well, or poorly they do this.


How do stock markets behave before a recession hits?

Monthly index price changes over ten US recessions (NBER classified) from 1958 to the last recorded COVID-19 recession in 2020 were analysed to test how much, if at all, equity markets fall ahead of recessions. Given its long history and global influence, our analysis began with the S&P 500 index.


To better understand equity market behaviour around recessions, a review of data should extend outside of the official start and end date of recessions. If analysis was limited to just the periods between the actual recession dates, we note that the S&P 500 has declined on average 2.9%, with certain recessionary periods seeing positive index movements. As noted above, recessions are only determined after they happened given the lag in economic data. Financial markets look forward and respond to the economic outlook. This means that the equity market performance picture changes quite significantly when reviewing market data from the point the index price peaks (before the official recession starts) to the point it gets to its lowest level (typically before the official end of the recession).


As shown in Figure 1, the S&P 500 has peaked on average seven months ahead of the official start of the recession and has seen average price declines of 26.4% from peak to trough. The price trough is always seen before the official end of the recession. Markets respond ahead of the official start with a pre-start decline, from index peaks to the official start of the recession, of an average 9.8%.

The results for the more tech-heavy NASDAQ Composite Index are similar to those of the S&P 500, but have some interesting differences. The index history is shorter with its first recession being the 1980 energy crises sparked by the Iranian revolution. Figure 2 shows the NASDAQ peaks on average six months ahead of the recession, much like the S&P 500, but falls more severely at around 38% from peak to trough. This is primarily a result of the 68% drawdown in the dot-com bubble-induced recession of the early 2000s. In the Global Financial Crisis (GFC), both the NASDAQ and the S&P declined two months ahead of the recession and fell around the same 50% from the pre-recession peaks to trough. It is also interesting to note that the NASDAQ fell on average 16.7% from peak to the official start of the recession. These movements support the idea that markets sell off ahead of recessions.

The small capitalisation Russell 2000 equity index has shown a quicker response to recession fears over its relatively brief history from 1978. It has on average peaked six months ahead of recessions since the 1980 recession. Small companies have had the second-largest average drawdown of 32% (after the NASDAQ’s largely dot-com-driven 34.7% decline), which one might expect given the vulnerability of small companies to changes in economic conditions. Smaller companies will struggle more to access capital to cover revenue declines in economic downturns and are typically not as well equipped to deal with falling demand and higher borrowing costs. These two elements are very common in periods of contraction.

There is the expression that when the US sneezes, other markets catch a cold. This has proven to be the case. We analysed how SA Equity performed around the period of these US recessions. The JSE All-Share (ALSI) has returned on average, since the recession of 1960, a pre-recession peak of four months, and has fallen 27% from its pre-recession peak to trough, similar to the S&P 500.

Where are we now? 

Figure 5 shows the average long-term peak to trough index declines ahead of recessions vs current index level declines from their various peaks, displaying how much markets corrected ahead of the official start of recessions.


One can see that substantial market correction occurs even before the economic slowdown takes place. This is because stock markets are discounting future impact on lower earnings, anticipating the slowing economy, potentially weaker sales and reductions in capex spend. As with our historical averages, the NASDAQ and the Russell 2000 are leading the drawdowns falling 32.7% and 29.8% respectively from their peaks to 13 June 2022. The NASDAQ has been impacted by price corrections from the “FANG” stocks given the sentiment around tech stocks in the US and China. The Russell 2000 fall, driven by small cap constituents’ general inability to source capital in tough economic climates, makes it difficult for investors to justify holding small companies over larger ones. Given larger companies’ well-established business models, and the lack of liquidity when trading small caps, investors typically seek to enter or exit the small cap market well ahead of favourable or unfavourable market conditions.


In Figure 5 we see that the South African equity market has “caught the cold”, but fared better than its US counterparts, largely driven by strong commodity prices post COVID-19, a strong performance from the financial sector driven by SARB’s interest rate increases to combat inflation, and a general global rotation into emerging markets given their historically-low relative valuations.

Implications for investors

The S&P 500 peaked on 3 January 2022 and has been in decline for five months. This is one of the fastest cycles of decline we’ve seen, and purely from index price changes (Figure 6), adds weight to our concern that the probability of a recession is rising. Our analysis indicates that both the NASDAQ composite and Russell 2000 have entered bear-market territories by falling more that 20% from their peaks, suggesting that at least a portion of the market is pricing in a very good chance of a recession in the next 12 months. These current declines are following historical patterns of market trading into concerns around recession. Historical averages therefore suggest a possible recession could be imminent. However, we don’t believe that the broader equity market is fully positioned for a recession yet, with the S&P 500 falling 21.8% from its January peak to June13th 2022 and we believe that markets could see more severe declines before a recession is fully priced in.


Without a significant pivot away from the hawkish stance that the Fed has taken, growing concern around more persistent inflation, slowing growth and elevated global political volatility driving up energy and food prices, we could see further outflows in equity markets as participants price in the imminent recession.


A glimmer of hope could be either an end to China’s zero-COVID policy leading to Chinese demand breathing life back into global markets, the Fed moderating the pace of tightening to reduce the odds of a recession from normalising inflation and softening growth and a speedy resolution to the conflict in Ukraine.


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