As an execution-only trader, taking no advice from third parties, it can be challenging to know how markets will react in a recession. For example, how long will the recession last? Will there be a rebound? Are there any particular sectors which could outperform on a relative basis?
Recession report by Capital Group
The Capital Group recently released a report, an in-depth look at ten previous US recessions, how they impact stock markets and how long you can expect them to last. While the timing of trade execution is crucial at any time, it can be even more critical in bear markets. After all, trying to catch a falling share price is like trying to catch a falling knife, dangerous!
How long does the average recession last?
As an execution-only trader, there may be the opportunity to go long and short on individual stocks or indexes. Consequently, before considering any trade execution, it might be interesting to know the average length of a recession.
According to the Capital Group report:-
• The average recession lasts just ten months
• The average reduction in GDP is -2.5%
• Net job losses have averaged 3.9 million
Whether you are an execution-only trader, an advisory client or simply someone with an interest in stock markets, it is essential to put this into context. The same report included information on the average period of expansion:-
• The average expansion period is 69 months
• The average GDP growth is 24.6%
• Net job gains have averaged 12 million
So, while trade execution can be difficult within a bear market/recession, it is essential to remember that the average recession is relatively short-lived compared to times of economic expansion.
Do equity markets predict economic cycles?
As an execution-only trader, knowing the potential predictive nature of stock markets is vital. Measured by their leading indices, the Capital Group report showed that equity markets tend to lead the economic cycle by 6 to 7 months. Some people believe the UK markets are around nine months ahead of the economic cycle, but maybe it is a little shorter?
Interestingly, this predictive nature is the same on the way down as it is on the way up. So, those looking to time their trade execution to perfection may be able to spot the upturn before it becomes a proven trend. As investors tend to be more optimistic than pessimistic, there is also a suggestion that markets bounce back much quicker than they fall. This is another crucial factor for execution only traders to take into consideration.
Which sectors fare best in a recession?
While this report was based on the US markets, it gives an insight into investor thoughts and trends in troubled economic times. Based on data covering ten periods of recession, the top (relatively) performing sectors were as follows:-
• Consumer staples outperformed the S&P 500 throughout all ten periods of recession
• Healthcare outperformed during nine periods of recession
• Utilities outperformed during nine periods of recession
• Telecommunication/communications outperformed during 8 out of 10 recessions
• Energy outperformed during five periods of recession
Execution-only traders should be aware of which sectors have historically shown relative strength during a recession. On the flip side, industrials, financials and information technology were the worst performers on a comparable basis.
Trends can change, but…..
While it is helpful to know how markets react during recession and times of economic expansion, it is not a given that historical trends will be repeated indefinitely. However, as an execution-only trader, it is essential to have an idea of how markets react and perform during different economic cycles. One of the most interesting facts is that US markets tend to reflect the economic landscape between 6 to 7 months in advance.