Data Brief - Weighing a Recession's Impact on Stocks

Weighing a Recession's Impact on Stocks

Saturday, January 5, 2008

Over the past several weeks, and helped along by Friday's weak payroll report, the chorus of opinions suggesting that we are in, or are headed for, economic recession have grown.

According to the latest figures from the prediction market Intrade, traders are putting a 55% probability on the idea that the U.S. will fall into recession in 2008.

But does it matter?

Recessions are notoriously difficult to predict consistently ahead of time, and after they are widely recognized, we are often already out of them.

The scorekeeper of U.S. economic activity is the National Bureau of Economic Research (NBER), and they publish business cycle data that outlines when they believe the U.S. entered and exited economic contractions (i.e. recessions).

There is a lot wrong with trying to invest or trade based on their data, as it is a badly lagging data series, and is subject to revisions well after the fact. But to get a general idea whether stocks do poorly during officially-recognized recessions, we took NBER recession dates and computed the returns in the DJIA, Nasdaq and S&P 500 indices between when recessions officially began to when they ended.

As you can see from the table below, stocks didn't do so well, showing maximum losses during the recessions that were at least 3 times greater than their maximum gains during those stretches. Speculative stocks like those found in the Nasdaq Composite were hit especially hard. If we are currently in, or headed towards, a recession, there may be some tough slogging directly ahead for stocks.