Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 479

Recessions are usually good for sharemarkets

Nothing scares investors more than talk of a recession. However, history shows that economic contractions have been mostly good for share prices and the Australian share market has actually increased during the majority of economic recessions in Australia. The same is true for the US share market during US recessions.

Timing is key

How is this possible? The key is timing. What causes share prices to fall is the fear of impending recession, not the recession itself if, or when it finally arrives. Share markets have almost always rebounded out of the middle of recessions, while the economy is still contracting, while profits and dividends are still being cut, and while news headlines are full of gloom and doom, rising unemployment, corporate layoffs and bankruptcies. 

Recessions and depressions

First, some definitions. An economic ‘recession’ is generally, but not always, defined as two or more consecutive quarters of negative economic growth.  The most recent exception to this definition was the 2020 Covid lockdown recession, when the US National Bureau of Economic Research (the body that calls US recessions) declared a ‘recession’ in the US lasting just two months (February-March 2020).

Before the 1940s, every economic slowdown was called a ‘depression’, but now the term is reserved for much deeper and longer economic contractions than mere recessions, accompanied by very high unemployment (say 20% or more), significant and sustained declines in aggregate incomes, commodities prices, trade and credit. In Australia, the main economic depressions were in 1930s, 1890s and 1840s, which were all global crises.

Timing between the start and the rebound

Share prices generally fall before economic contractions start and then start rebounding while economies are still contracting. This chart illustrates how the cycles work:

The timing of each part of the cycle almost always follows the following order:

A. Share prices start falling in anticipation of profits falling in an upcoming economic slowdown but while aggregate company profits and dividends are still rising.

B. Economic activity starts contracting (such as negative growth in real GDP). Because of delays in reporting national economic numbers, by the time negative growth is reported, the share market has already been falling for several months in most cases. Even the short, sharp 2020 Covid recession, when the March quarter economic contraction in Australia was announced in May, the share market had already started to rebound strongly from late March.

C. Aggregate company profits start falling due to slower revenues and often rising interest rates, usually well after share prices have started falling (A), and also usually after economic activity starts contracting (B). Often, some company profits are still surging well into economic contraction. Aggregate company profits fall by much more than the reduction in economic output because companies have operational and financial leverage, and narrow profit margins. For example, in a serious recession, GDP might fall by say 3%, but aggregate profits and share prices might fall by 30-40% or more.

D. Dividends start falling, but cutting dividends is usually the last resort of company boards in a crisis. Generally, companies try to maintain dividends in order to retain investor confidence and support the share price, even though profits have fallen. The fall in aggregate dividends is always less than the fall in aggregate profits. 

E. Then share prices start rebounding, usually while economic activity is still contracting in the middle of a recession, while profits and dividends are being cut. 

F. The economy starts growing again but well after the start of the rebound in share prices. In most cases, by the time the economy starts growing again, share prices have more than recovered their falls during the recession itself. As a result, the actual periods of recessions (when economic growth is contracting, from points B to F), share prices actually rose in the vast majority of cycles.

G. Aggregate company profits rebound, well after start of rebounds in share prices (E) and economic growth (F).

H. Dividends are finally raised, as balance sheets and profitability are restored – well after the start of the rebounds in share prices (E), economic growth (F), and profits (G).

The net result of this consistent pattern is that the share market has risen during the vast majority of economic recessions (point B to point F on the chart). 

Where are we now on the chart?

The US (which drives all global markets) and Australian stockmarkets are probably around point B on the chart. Share prices have already fallen in anticipation of rate hikes cutting into consumer spending, leading to lower corporate profits and dividends, job losses and economic contractions. Whether or not there is a recession is not as important as the fear of significantly lower profits and dividends.

Although the US economy actually contracted in the first two quarters of 2022, the National Bureau of Economic Research is not yet calling it a recession as household spending and jobs remain strong. Also, corporate profits and dividends are still rising, albeit at slower rates than in 2021. Australia also has strong jobs, spending, profits and dividends. Even in Europe and the UK, economies are probably already contracting, but jobs, spending, profits and dividends remain strong, although China is contracting.

Large sections of the US share market in particular are still over-priced, although the Australian market is probably now around ‘fair value’. When economic recessions do arrive, they will be marked by mass job losses and bankruptcies, as in numerous previous cycles. When sharemarkets rebound, it will be when doom and gloom is greatest, unemployment and corporate failures are rising, and companies are posting big cuts to profits and dividends. Rebounds have always been faster and stronger than investors expect, and they start when fear and uncertainty are greatest (when there is ‘blood in the streets’, says Warren Buffett).

21 recessions in 150 years

Australia has had 21 recessions since the 1880s, based on the conventional definition of at least two consecutive quarters of negative growth in real GDP. 

The next chart shows changes in the share price index during each of the recessions since the 1880s in Australia. Almost all are in the upper sector of the chart – the broad sharemarket rose during the recessions.

In summary:

  • The broad sharemarket index rose during 17 (81%) of the 21 recessions in Australia since the 1880s.
  • Aside from the very short, sharp 2020 Covid sell-off, share prices rose during each of Australia's previous nine recessions, since the 1938-39 recession, when share prices fell by just 1.8%.
  • In the recent well-known recessions, sharemarkets rose during each of them. These included: Keating’s 1990-91 ‘recession we had to have’, the long 1981-83 recession, the 1975 Whitlam inflation recession, and the 1971-72 mining collapse recession.

Recessions (contractions 2q or longer)

Aside from a couple of minor share price falls during the 1938-39 recession and the 1914-15 WWI recession, the only recession or depression in Australia that was accompanied by big share price falls during the period of the economic contraction was the 1929-31 depression when shares fell by 60% during the period of contraction.

In fact, some of the best years for shares are when the economy was contracting or still weak, including 1983, the best ever calendar year for Australian shares (up 60%), during the 1981-83 recession.

This is a reminder to ignore media scare mongering. In particular, by the time the recession hits, most of the share market fall is probably already in the past. The great share market surges start when the media headlines are full of doom and gloom, rising jobless rates, corporate bankruptcies, losses, and dividend cuts.

 

Ashley Owen is Chief Investment Officer at advisory firm Stanford Brown and The Lunar Group. He is also a Director of Third Link Investment Managers, a fund that supports Australian charities. This article is for general information purposes only and does not consider the circumstances of any individual.

 

9 Comments
John
October 16, 2022

In a bad recession quite a few companies go belly-up. So the sharemarket after a recession is not the same as before. Bad luck for those who held the shares that went bad. The argument of Ashley's also implies that some shares gain a lot of value during and/or after the recession. Sadly it is not given to mere mortals to know the future.

Ted
October 15, 2022

My view is that in a recession share prices fall at first and then rise from the rock bottom. Whether share prices rise or fall in a recession depends on how much of the recovery phase is counted in the time of the recession. The NBER definition of recession is nonsense for investors but may be OK for those economists who look for a broad range of lagging indicators, often 6 months out of date.

Ted
October 16, 2022

After commenting on the HSC Economics article I am reminded that the graph needs an overlay for monetary policy, fiscal policy and microeconomic policy. That is why 'this time is different'. Monetary policy has been wrong (apologies accepted), fiscal policy has been a disaster and has left monetary policy to do the hard work, and micro policy - what micro policy? the NEG? Same in the US. Not to mention external economic policy - trade wars, brexit..supply chain problems brought on by ourselves. Who has a model for our economy that works and has reliable economic forecasts?? So we are around B on the graph but what next?

Ian Whitehall
October 13, 2022

An interesting read, we can only hope that this downturn follows the route of former downturns and the market bounces back. In the short time period, I'm of a mind to think we may well be in for a bumpy ride, and none of us has a Chrystal ball to tell us what the future holds.

Terry Williams
October 12, 2022

Hey Ashley. As always, love your work. Wondering if you might RING THE BELL for me when it’s time. Best Terry The Telecaster

ashley owen
October 16, 2022

Hey Terry
'63Strat here - thanks for the feedback! I go through each and every recession/share market cycle in the full paper on the Standford Brown website - probably not allowed to put link here.
On the timing - we are still a fair way from the turnaround to the next big boom - that is usually when central banks are cutting rates, when unemployment is soaring, companies are failing everywhere, media is full of 'end of the world' stokes, etc.
cheers
ashley

Peter
October 12, 2022

I think it comes down to experience, Kevin. How many good news stories in most papers do you see in comparison with bad news; not many.The majority of people are so used to doom & gloom that they forget to look for the good bits & there are many. Remember Buffet's saying." be greedy when others are fearful & fearful when others are greedy. It has a lot of merit. Long term in the market & you will win.

Warren Bird
October 12, 2022

Good article Ashley. Totally agree. The fall in markets that we've already seen is anticipating the recession that the tightening of monetary policy may cause and thus any further fall once recession arrives (if it arrives) will see the market anticipate the recovery. To Kevin, I wouldn't worry too much about the noise. If it was really having an impact then the market wouldn't actually follow the trajectory that Ashley has outlined! Mind you, the media seems to have learned the lesson of Ashley's warning in his last paragraph. They often publish two articles on the same front page these days - one bearish and one bullish - so that they can always say 'we told you so'.

Kevin
October 12, 2022

I agree,BUT,how do we get people to think,how do we get people to turn off the noise,how do we teach people that aiming for a low income is a bit dumb.How can we explain that compounding takes time.Why do people deny the obvious?

 

Leave a Comment:

RELATED ARTICLES

Why are recessions usually good for share prices?

Most Australians live better than the Rockefellers

Don't be fooled: a recessionary hit is coming

banner

Most viewed in recent weeks

2024/25 super thresholds – key changes and implications

The ATO has released all the superannuation rates and thresholds that will apply from 1 July 2024. Here's what’s changing and what’s not, and some key considerations and opportunities in the lead up to 30 June and beyond.

Five months on from cancer diagnosis

Life has radically shifted with my brain cancer, and I don’t know if it will ever be the same again. After decades of writing and a dozen years with Firstlinks, I still want to contribute, but exactly how and when I do that is unclear.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

Why LICs may be close to bottoming

Investor disgust, consolidation, de-listings, price discounts, activist investors entering - it’s what typically happens at business cycle troughs, and it’s happening to LICs now. That may present a potential opportunity.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Latest Updates

Shares

Exploiting Warren Buffett

Growth investors are using Buffett to justify buying blue chip stocks at almost any price. It’s a recipe for potential disaster, as investors in market darlings like CBA and Cochlear may be about to find out.

Property

Population density trends and what they mean for housing

With Australia’s population moving through the fastest rate of growth since the 1950s, our cities and towns are naturally densifying. This is a look at the latest trends and how they will impact the property market.

SMSF strategies

The ultimate superannuation EOFY checklist 2024

We're nearing the end of the financial year and it's time for SMSFs and other super funds to make the most of the strategies available to them. Here's a 24-point checklist of the most important issues to address.

Shares

The outlook for Nvidia, from a long-time investor

Nvidia has taken the world by storm and is now the third largest stock on the planet - larger than Meta, Amazon, and Alphabet. Here is the latest take on Nvidia from a fund manager who first invested in the company in 2016.

Economy

Gross National Happiness?

Despite being richer, surveyed measures of happiness have been flat to falling in Australia. Some suggest we should focus less on GDP and more on broader measures of wellbeing, though there are pros and cons to that approach.

Shares

The power of dividends

In an era where growth companies dominate and the likes of Nvidia grab all of the attention, dividend paying stocks are flying under the radar. Some of these stocks offer compelling prospective returns.

Fixed interest

The best opportunities in fixed income right now

After more than a decade of pitiful yields, bonds are back offering better prospects for income investors. What are the best ways to take advantage of the market inefficiencies in Australian fixed income?

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.