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Recessions and the impact they have on stock markets

by Ozva Admin

For a recessionary environment to occur, economic activity should be declining, which is almost the case in the UK.

There is no doubt that an economic slowdown is taking place. For many UK consumers, the biggest impact is felt in the cost of living, with rising energy and fuel bills having the biggest drop in income. Consumers now have to make tough choices between spending on necessities and non-essential goods. Discretionary spending is being cut in areas like recreation, travel, alcohol, and home furnishings. These are clear signs of a slowdown, if not an outright recession.

For a recessionary environment to occur, economic activity would have to be declining, and this would be evident in lower real GDP, real income, employment, industrial production, and retail sales. During June 2022, the UK experienced month-on-month declines in real GDP of -0.6%. So some of the signs are already there, but the UK economy is not officially in recession yet. You need to see two consecutive negative quarters of real GDP before you enter a technical recession.

Signal reading

Google Trends suggests that a UK recession is largely inevitable and has probably already started. It is a powerful tool for measuring consumer sentiment. The graph below shows search interest for the word ‘Recession’ in the UK, recorded on a range of 0-100, with 100 reflecting peak popularity. As you can see, periods of peak popularity align well with past recessions. In fact, the Bank of England predicts that the UK will be in recession by the end of the year and over the course of 2023, so we’re almost there.

Source: Google Finance

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

Source: Commercial Economics

Stock markets look to the future, so they often reflect the weak economic environment before the worst happens. In contrast, economic data is retrospective and is published periodically. This makes the timing of the stock markets, in most cases, useless. If you’re making decisions based solely on data, you’ll 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 period for investors, and currently fear remains high. The markets may have breathed a sigh of relief more recently, but it is too early to say whether we will see a sustained market recovery. Investors will wonder whether to sell while stock markets remain volatile, but don’t forget Warren Buffett’s wise words: “Be afraid when others are greedy and greedy when others are afraid.” After periods of low returns, portfolios need time to recover and, in our opinion, selling now only crystallizes losses. Investment in the rear view mirror has never led to success. 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 taken as investment advice.

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