(Baird’s Ross Mayfield wrote the following piece in late July 2022)
THE S&P 500 VS. RECESSIONS
During 2020, I was most often asked, “why is the stock market doing so well when the economy is doing so poorly?” A fair question. By the time Q2 GDP was announced on July 30, 2020 – a historic 33% drop – the S&P 500 was only 4% below its all-time high. From there, it would rally 16% into year-end, even though Covid-19 vaccine data was not published until November.
So why the discrepancy? Because ultimately, stocks are always looking forward, while economic data looks backward; the stock market and the economy will never line up one-for-one. While economists are improving at utilizing real-time indicators, most economic data takes time to collect, parse, and report. It reflects what has happened – not what will happen. For example, GDP is a quarter’s worth of information, but the final reading is not reported until months later, resulting in a major lag. It is still useful information, of course, but it is simply looking in a different direction than the market. Stock prices, on the other hand, are forward-looking, the culmination of tens of thousands of investors staring at the horizon, evaluating the landscape, and discounting their read on the future back to the present.
The result is that market activity and economic data – including recession timing – will almost never line up perfectly. In fact, as we show in the chart below, the stock market often peaks well in advance of recession, and almost always bottoms before the recession ends. This fits with data from an earlier “In the markets now” note highlighting the strength of average returns 1, 3, and 5 years out from the beginning of a recession – by the time a recession begins, a lot of pain is already priced into the stock market.
Perhaps the biggest takeaway is that sustained market rallies often begin when the economic picture is at its worst and have usually bounced considerably by the time of the proverbial “all-clear.” It also means that an S&P 500 that was down 24% in June – 9th worst selloff of the last 75 years – has priced in a lot of future bad news (e.g., recession). The exact timing can vary widely, but the basic relationship is worth remembering as recession talk ramps up.
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