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What Happens to the Stock Market During a Recession? Here's What History Tells Us
We're most likely already in a recession. The U.S. economy dropped for the second consecutive quarter, with GDP contracting 0.9% in Q2 after falling 1.6% in Q1.
Officially, the United States will not be in a recession unless eight economists declare it such. These economists serve on the Business Cycle Dating Committee of the National Bureau of Economic Research.
Investors will be concerned about the stock market before the official announcement of a recession. But how does the market do during a downturn? This is what history has demonstrated thus far.
The S&P 500 does not fully reflect the stock market. It only contains the 500 largest publicly traded corporations on U.S. stock exchanges. The S&P 500, on the other hand, has long been seen as a strong proxy for the broader market. Now, because the index has been around for 65 years, it allows us to examine how the stock market performed during most post-World War II recessions.
The greatest S&P 500 loss happened during the Great Recession, which lasted from December 2007 to June 2009. The index fell as much as 55% from its last top in March 2009.
However, it was a far worse recession than usual. During post-World War II recessions, the average S&P 500 loss is roughly 29%. This average is skewed, however, due in part to the very severe sell-off during the Great Recession. The average drop is roughly 24%.
Unsurprisingly, the S&P 500 always falls during a recession. As customers tighten their wallets, several firms report reduced profitability. Investors frequently respond badly to any unfavourable news.
There are two key characteristics about how the S&P 500 has performed during recessions. First, in many cases, the index fell precipitously prior to the formal start of the recession. Second, the S&P 500 typically began to recover far before the recession ended.
It makes sense for the S&P 500 to fall before the commencement of a recession. Investors are often forward-thinking. Most recessions are not unexpected, yet the COVID-19 recession of 2020 was an aberration.
Investors typically detect early warning signals of a probable recession and frequently become more cautious in advance. This risk-averse mind set can have a big influence on markets before a recession occurs.
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