Recessions and their impact on stock markets

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For a recessionary environment to occur, economic activity would have to be in decline, which is almost the case in the UK.

There is no doubt that an economic downturn is underway. For many UK consumers, the biggest impact is felt on the cost of living, with rising energy and fuel bills having the greatest pressure on income. Consumers now have to make tough choices between basic necessities and non-essential goods. Discretionary spending in areas such as recreation, travel, alcohol and furnishings is reduced. These are clear signs of a slowdown, or even an outright recession.

For a recessionary environment to occur, economic activity would have to be in decline, which would be manifested by a decline in real GDP, real incomes, employment, industrial production and retail sales. In June 2022, the UK experienced a monthly decline in real GDP of -0.6%. So some of the signs are already there, but the UK economy is not yet officially in recession. It must experience two consecutive negative real GDP quarters before entering a technical recession.

Read Signals

Google Trends suggests that a UK recession is largely inevitable and has probably already started. It is a powerful tool to gauge consumer sentiment. The graph below shows search interest in the word ‘recession’ in the UK, recorded over a range of 0-100, with one hundred reflecting the peak in popularity. As you can see, periods of peak popularity correspond well with past recessions. Indeed, the Bank of England predicts that the UK will be in recession by the end of the year and into 2023 – so we are almost there.

Source: Google Finance

Recessions usually don’t last long. Since the turn of the 20th century, the average recession in the UK has lasted 1.15 years and we have had 10 in those 120 years. This year so far has been a tough time for equity investors and technically we’re not even in a recession yet. But the analysis of the last three recessions: the recession of the early 1990s (Q3 1990 – Q3 1991), the Great Recession (Q2 2008 -Q2 2009) and the COVID-19 recession (Q1 2020 – Q2 2020), helps to explain this. The chart below shows that past market performance before the event is usually much worse than during. In other words, stock markets and recession cycles are generally not synchronized.


Source: Trade Economics

Stock markets are forward-looking and therefore often reflect weak economic conditions before the worst happens. Conversely, economic data are retrospective and published periodically. This makes stock market timing, more often than not, unnecessary. If you make decisions based solely on data, you will often be too late. Behavioral finance tells us that investors can make poor investment decisions based on emotions and cognitive biases.

Don’t look back in anger

The first half of 2022 was an uncomfortable time for investors, and currently fear remains high. Markets may have breathed a sigh of relief more recently, but it’s too early to tell if we’ll see a sustained market recovery. Investors will wonder whether to sell as equity markets remain volatile, but remember the wise words of Warren Buffett: “Be fearful when others are greedy, and greedy when others are fearful.” After episodes of lackluster returns, portfolios need time to recover and, in our view, selling now only crystallizes losses. Investing in mirrors has never been successful. So for us the message is clear. Now is not the time to lose sight of your long-term financial goals and objectives. Keep your eyes on the road ahead.

Simon Molica is an investment manager at Parmenion. The opinions expressed above should not be considered investment advice.

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