On Wall Street these days, the big concern is that an economic recession is heading toward the U.S. Traders are worried about this, and it’s keeping them on the sideline. The data from the past 11 recessions reveals key information about economic recessions and bear markets which traders should pay attention to.
The U.S. equity markets are down significantly year-to-date (YTD): The S&P 500 index is down by 14%, the Dow Jones 10%, and the Nasdaq 23.82%. A bear market occurs when an index falls 20% from its all-time high or recent highs. According to the National Bureau of Economic Research, which officially declares recessions, a recession is a major fall in economic activity that lasts more than a few months and is observable in real GDP, real income, employment, industrial production, and wholesale-retail sales. That’s a change from how it used to be defined, as two consecutive quarters of decline in real GDP.
Stocks have been struggling mainly because inflation is soaring, and the Fed has adopted the most hawkish monetary policy in decades to lower inflation. A hawkish monetary policy is cutting into U.S. economic growth.
In May this year, the most recent U.S. Consumer Price Index (CPI) reading was released, and the number came in at 8.3%, the highest since 1982. Investors are worried that this inflation reading has yet to reach its peak level, and it could be a few months, if not quarters, before we see inflation hitting peak levels.
Higher inflation readings are keeping the Fed in a difficult spot and the Fed doesn’t have any other option but to continue to tighten the screws of its monetary policy by increasing interest rates at the most aggressive pace in decades, in addition to reducing the size of its balance sheet.
The S&P 500 index dipped into bear market territory briefly last week, but so far, has not yet closed in bear market. But traders believe that with economic data displaying weakness, a recession is likely to happen within the next few months, if not earlier, and that will push stocks further down.
If history repeats itself, what traders believe is not far off from what the past data shows. I have looked at all economic recessions going back to 1929, and almost every time, a recession began before a bear market. The average drop for the S&P 500 during the past 11 economic recessions was 40%, and the medium decline was 34%. The medium length of the last 11 recessions lasted 14 months, and the average was for 15 months.
As the economic data has already started to show weakness, and inflation has yet to peak, it is highly likely that we may see an economic recession first before we officially enter a bear market.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.