What we know and don’t know about today’s stock market

The stock market is forward-looking. This means its movements—whether up or down—usually precede economic reports. This anticipatory nature tends to hold true when comparing GDP growth and stock market returns.

Why is this important? Because many people are concerned about an upcoming recession and how the market will react. (Recall that the unofficial definition of a recession is two consecutive quarters of negative GDP growth.)

Here are six charts showing past recessions. What do we know about the relationship between the stock market returns and slowing economic growth? In each one, except the first part of the 1980s double-dip recession, the stock market bottomed before economic growth fell to its low.

Line chart

What we don’t know…and know

No one knows when a stock market bottom will occur. But we do know that the average peak-to-trough decline in the S&P 500 during recessionary periods is about 32% on average[1]. When the S&P 500 was down only 14% this year,[2] some people looked at that decline as the market saying there’s a 50-50 chance of a recession. Any decline of more than that may indicate the likelihood of a recession appears even higher in investors’ minds.

We also don’t know if economic data may worsen. Every recession is different and the major risks to growth today are varied, ranging from supply chain problems, China’s ongoing battle with COVID, the Russia-Ukraine war, and central bank tightening.

But we do know that certain U.S. equity benchmarks (large cap, small cap, growth) fell by 20%-30% in 2022 from peak levels and the average stock in the Nasdaq, Russell 1000 Growth Index, and the Russell 2000 Small Cap Index was down even more—some roughly 40% to 50% or more from peak levels.[3] At the same time, U.S. GDP growth has experienced two negative quarters this year, although a recession has not been officially called.

What else do we know? Investors often contemplate selling their stocks in a market drawdown with the plan of hopping back into the market when it bottoms out.

But (again!), no one knows when that turning point may occur. But we know that trying to time the market usually fails. And those investors who miss that turn—miss the best days of the market—see their long-term returns cut, sometimes by as much as half or more.[4]

Disclosures:

The investment advisor for each fund is Motley Fool Asset Management, LLC (“MFAM”). MFAM is a wholly owned subsidiary of Motley Fool Investment Management, LLC, whose parent company, The Motley Fool Holdings, Inc., which is a multimedia financial-services holding company. MFAM, an affiliate of The Motley Fool LLC (“TMF”), is a separate legal entity. No TMF analyst is involved in the investment decision-making or daily operations of MFAM. With respect to its actively-managed funds, MFAM does not attempt to track any TMF services and, as such, those funds may diverge completely from TMF’s services. The information contained herein does not take into account the particular investment objectives or financial circumstances of any specific person who may receive it.

 


[1] Bank of America Global Research, Apr. 29, 2022.

[2] Through June 8, 2022

[3] JP Morgan Eye on the Market, Michael Cembalest, June 7, 2022

[4] JP Morgan Asset Management, data from Jan. 1, 2002 through Dec. 31, 2021

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