A short historical view of markets’ path out of recession.

In this article we are taking a brief look at recessions and recoveries over time. Throughout history, the stock market has demonstrated an incredible ability to recover from periods of volatility and downturns. . . .

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Recession and correction recoveries

In this article we are taking a brief look at recessions and recoveries over time. Throughout history, the stock market has demonstrated an incredible ability to recover from periods of volatility and downturns. While there will always be periods of uncertainty and volatility – Mr. Market is quite manic depressive – the stock market has shown that it is resilient and that recoveries are always possible.
 

Currently the mood is starting to shift towards expectations of lower-than-expected inflation and thereby a possible slower pace of interest hikes. Graph 1 shows the duration of bull and bear markets as well as the recovery pace. Duration of recessions are shown as grey columns in the graph. We are using US data as that is the only available market data with such a long history. The recovery after severe drawdowns and recessions have historically been swift.
 

Covid 19 is the shortest recession in history. The drop in market prices ended less than a month after start. Market participants quickly realised that the collapse in economic activity was self-imposed and expected a swift rebound in growth. Stock markets are not always down during a recession. Stock markets can rise or fall during a recession depending on the state of the economy. Factors such as the availability of capital, consumer confidence, and the performance of specific companies or sectors can have an impact on stock prices. Additionally, governments can intervene in the markets by enacting policies that affect the markets, such as increasing or decreasing interest rates.

If history repeats itself, recoveries have followed declines, and long-term investors may benefit from the recovery.

Figure 1. Source: FactSet. Daily data from 3 January 1928 through 30 January 2023. Bear market is defined as the period from a peak to trough, with at least a 20% decline in the S&P 500 index price. Data in USD. Past performance is no guarantee of future results. Max drawdown is the largest drawdown (peak-to-trough) within each calendar year. Benchmark S&P 500.

Figure 2. Source: FactSet. Daily data from 3 January 1928 through 30 January 2023. Bear market is defined as the period from a peak to trough, with at least a 20% decline in the S&P 500 index price. Data in USD. Past performance is no guarantee of future results. Max drawdown is the largest drawdown (peak-to-trough) within each calendar year. Benchmark S&P 500.

The table below lists the 15 recessions recorded during the last 100 years or so. The average length of recessions in modern times after WW2 is about 10 months. There is a lot of confusion about what makes up an official recession and how long they typically last. A common definition is: “significant decline in economic activity that is spread across the economy and lasts more than a few months“. It interprets this definition using three criteria — depth, diffusion, and duration — in a somewhat interchangeable manner. While a recession needs to meet each factor to some degree, there are extreme cases where the severity of one component can partially offset the lack of another.
 
An example is the economic decline in early 2020 due to Covid-19 that was so severe and widely dispersed that it was classified it as a recession despite a very short duration.
 

Table 1.

The graph below depict development since 1926 showing downturns, recovery and price increases. The data is shown in logarithmic scale. The original data is super imposed in Original Data graph.
 

Figure 3. As this graph is displaying nearly 100 years of data, we are using logarithmic scale as it is a way of displaying numerical data over a very wide range of values in a compact way—typically the largest numbers in the data can be hundreds or even thousands of times larger than the smallest numbers. 

 
Who are the likely post-recession winners?
The post-recession winners can be broadly categorized into three groups:
 

1. Large multinational companies: These large companies have been able to take advantage of globalization and the digital revolution to create new opportunities for growth and profitability. They have also been able to benefit from the low-interest rate environment which has allowed them to borrow money cheaply. After 2009 bottom out until 2015 large caps outperformed with 35%-units.
2. Technology companies: Major technology companies have seen tremendous success over the past decade as the digital revolution has taken hold. These companies have been able to take advantage of new technologies to create innovative products and services that have changed the way we live. After 2009 bottom out until 2015 large caps outperformed with 135%-units.
3. Small businesses: Small businesses have been able to take advantage of the post-recession economic environment to launch and grow quickly. The low-interest rate environment has allowed smaller businesses to borrow money more easily and the digital revolution has helped them access new markets. After 2009 bottom out until 2015 large caps outperformed with 50%-units.

Companies that master the subtle balance between cutting costs to survive today and investing to grow tomorrow seem to prosper after a recession. A subset of this group that deploys a specific combination of defensive and offensive moves has the highest probability of standing apart from the crowd. These companies reduce costs selectively by focusing more on operational efficiency than their competitors do, even as they invest relatively expansively in the future by spending on marketing, R&D, and new assets. The challenge this time is that the inflation is primarily supply driven. This means that it is quite difficult to curb with higher interest rates, as this will mainly affect the demand side. It will be a rare feat if Central Banks can pull off a soft landing, and the jury is still out on that.
 
Interestingly, this coming slowdown in economic growth is very well understood by investors and therefore, to a large extent already priced into the market. This can for example be seen in increased cash positions. So given that there will be no serious policy error by the major central banks, there is plenty of dry powder waiting to be used if the soft landing actually happens.
 
So, what lies ahead? In 2023, the stock market is expected to remain strong, with economies continuing to recover, and corporate profits and dividends increasing. However, there are some concerns over inflation and rising interest rates. This could put a damper on stock prices, but the market should remain relatively healthy, and the interesting question is where we are a few years ahead. If history repeats itself there could be some interesting years coming up.

Peter Sjoeholm, CEO

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