While the economy may continue to soften in coming months, history also shows us that markets tend to be forward-looking and can start to recover even as economic and earnings measures continue to decline.
Over the past several weeks, and especially since the last Federal Reserve meeting, market volatility has been back. The S&P 500 has entered bear-market territory once again, down about 23% for the year. And while there had been debate around whether the economy could emerge from this tightening cycle in a "soft landing," financial markets now broadly seem to be pricing in a new scenario: A recession is on the horizon.
While every cycle is unique, history can offer some guideposts on returns around recessionary periods. Historically, market downturns in average or shallow recessions tend to be around -25% to -35%, and last around 10 to 15 months. The recovery period can also range from nine months to two years. Keep in mind that in deep recessions, the losses and recovery times can nearly double, but typically they are accompanied by some structural or systemic issues, which have not yet emerged in the U.S. economy. With equity markets down over 20% currently, much of the work to the downside may have been put in already, as financial markets price in the economic downside ahead.
While the economy may continue to soften in coming months, history also shows us that markets tend to be forward-looking and can start to recover even as economic and earnings measures continue to decline. The question that investors may be asking now is, "What are the key signals to look for that show a market bottom is in place?"
Market bottoms (and market tops) are notoriously difficult to time. It is better for investors to have time in the market than to try to time themselves in and out of the markets. Nonetheless, there are signals to monitor that may help indicate that a bottoming process is underway :
The good news for investors is this: Since 1935, any time the S&P has fallen more than 20% in one calendar year, the returns in the following year are positive, and by an average of about 25%. So for long-term investors, this bottoming process may also be an opportunity – to diversify, rebalance, or put new capital to work in quality investments at potentially better prices – ahead of a potentially robust recovery.