Insights

Here’s the Good News for Investors If We’re in a Recession

My late grandmother had a favorite expression any time she was about to go somewhere. She’d say, “Let’s go so we can get back.” Her favorite place was home, so leaving quickly shortened the period of time until her return.

I thought of my grandmother’s saying last week when the news broke that the U.S. economy contracted for the second consecutive quarter. This met the rule of thumb for a recession, although the National Bureau of Economic Research hasn’t officially declared a recession yet.

Some might hope, like the Biden administration, that use of the “R” word is premature. However, investors should prefer that a recession actually is underway already than having one begin later. There’s some good news for investors if we’re in a recession.

Image source: Getty Images.

Stocks rebound faster than the economy

Yes, the stock market falls during a recession. That’s always been the case during recessions over the past 70 years. Without exception. But it’s important to understand that stocks often rebound faster than the economy does.

For example, perhaps the best parallel with today is the recession that began in mid-1981 and extended throughout much of 1982. The Federal Reserve steadily increased interest rates to fight soaring inflation back then. We’re seeing similar moves today.

^SPX data by YCharts

Note that the S&P 500 began to make a sharp comeback months before the recession ended. The index was actually higher before the recession was over than it was before the recession began.

Investors are forward-looking. They can often see the signs of companies’ businesses improving in advance of improvement showing up in economic indicators. As a result, the buying pressure that sends the stock market higher can frequently precede the end of a recession.

Historical post-recession performance

Kristin McKenna, Managing Director at Boston’s Darrow Wealth Management, did some research about how the stock market has performed historically following recessions. Investors have a lot to like about those findings. 

McKenna looked at all U.S. recessions from 1953 through the COVID-19 recession of 2020. During that period, the stock market delivered positive returns in the six months after a recession ended 82% of the time. Granted, the average return was only 7%, but there was even better news.

In the 12 months following a recession, the stock market achieved a positive return 91% of the time with an average return of 16%. The only period in which stocks didn’t generate solid gains within 12 months after the end of a recession was 2001 when the dot-com bubble burst.

Interestingly, McKenna found that stocks typically performed worse during the year leading up to a recession than during the recession itself. That could bring at least some level of comfort to investors today if we’re indeed in a recession now.

An investor’s best friend

Of course, the wisest investors think with even longer-term perspectives rather than focus only on recessions and their immediate aftermath. They see downturns as opportunities.

Warren Buffett stands out as a great example. The legendary investor, nicknamed the “Oracle of Omaha,” wrote in 2008, “Bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.” 

We’ll probably find out relatively soon if the U.S. is officially in a recession. Even if it is, there’s likely a silver lining for investors. The sooner a recession begins, the sooner it ends — and the sooner stocks could be poised for a major comeback.

The Motley Fool has a disclosure policy.

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