Thursday, June 8, 2023
- The median timing of the National Bureau of Economic Research’s (NBER) recession calls has been nearly coincident with recession-associated market bottoms, although the dispersion has been very wide.
- That shouldn’t be surprising. NBER doesn’t call a recession until there’s a high degree of certainty that we’re in one. On average, that should be roughly when the market has fully priced the recession in.
Let me say right off that LPL Research doesn’t believe we’re currently in a recession, although we do believe the start of a recession seems likely over the second half of the year. But if we were to have a recession, we believe it would probably be shallower and more short-lived than they have been historically.
Recessions, when they have occurred, have tended to be disruptive for riskier assets like stocks. The average peak to trough S&P 500 Index price decline associated with a recession has been 29.6% going back to 1937, covering 14 recessions. The pre-recession market peak has occurred a median of 4.2 months before the recession starts. The market low has taken place a median of 5.2 months after the start of the recession or 4.4 months before the end. A mild recession, with some risks already priced in, would likely be less disruptive than what we’ve typically seen historically, but would still demand some attention.
How would we know when we are there? NBER is widely accepted as the arbiter of U.S. recession dating. NBER’s job, though, is not to call recessions, but to date them. That is, they’re acting as economic historians rather than real-time diagnosticians. NBER will make a call when they believe an economic peak or trough is “not in doubt” and can be accurately dated.
Not so coincidentally, by the time NBER makes a recession call, on average, the market disruption may have run its course. As can be seen in the table below, the median time from NBER’s recession calls to the market bottom has only been about half a month or roughly two weeks. This is a fun data point and there’s some logic to it, but we should also be careful with it. There aren’t a lot of these live calls. They’ve only been taking place since 1980. That’s a long time, but recessions are infrequent, so we’ve actually only had six recession announcements. And as always, you have to be careful with averages since what has happened in any particular recession can be quite different from the average.
Even with that dispersion relative to the bottom, the track record for the S&P 500 has been pretty good after NBER’s calls. Over the next three months, near-term volatility has typically persisted with minimal gains. But the market has been meaningfully higher, on average, a year later. The only decline was the multi-year bear market associated with the “dot com” bubble bursting and subsequent accounting scandals.
Why does it take so long before NBER believes it has the information it needs to make a call? There are several factors, including delayed economic releases relative to the period they’re measuring. There are also always revisions as more data is collected. During periods of large economic changes (recessions, for example) revisions can be particularly large, as standard estimating techniques may not work as well, seasonal effects can get distorted, and data gathering may be more difficult. There’s also a certain amount of clearance needed to get the certainty needed to make a call. The economy can’t just cross a line—the turnaround needs to be sufficiently strong to be sustainable.
While that makes dating a recession difficult, the certainty that NBER requires may help its announcements provide a rough clue to market bottoms, since NBER’s criteria means markets have likely fully priced in the recession when it makes a call. More coincidentally, the time it typically takes to make a market call roughly corresponds to the amount of time it takes for a declining economy to reach an inflection point—the point at which things are still getting worse but more slowly. Seasoned investors sometimes use these inflection points, informally called “green shoots” or sometimes “the second derivative test,” to begin to project better times ahead.
LPL Research recently downgraded equities to neutral and upgraded bonds. The call is not bearish, just moderately cautious with higher yields making bonds both more attractive from a return perspective and more likely to serve in their more traditional role of portfolio diversifiers if we were to get a period of equity volatility. For more on our equity call, see our discussion in our recently released Weekly Market Commentary, Closing Out Our Equity Overweight.
While we would not use a potential NBER recession call as a timing tool to add back to equities, we do believe the call would probably occur within the rough time frame when a preponderance of evidence might point to adding risk back to portfolios.
Of course, knowing what markets may do around recession calls provides no information if we don’t actually get one. But when to potentially add to equities in that situation is the subject of a future blog.
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