The U.S. Election, Recessions and the Stock Market | Lord Abbett
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Economic Insights

Investors may be looking past the current uncertainties, but market performance will depend on how quickly full economic recovery is anticipated.

Read time: 4 minutes

In September, the market appeared to stall out, as the Standard & Poor’s 500 Index slipped more than 6% from a record high earlier in the month. This may have reflected disappointment with the lack of follow-through on U.S. fiscal policy, as income support for households, state and local governments, and businesses has been sharply reduced or allowed to expire. Investors may even have begun to be concerned about a double-dip U.S. recession.  

But the market is forward-looking, and, historically, has anticipated the eventual economic rebound. In today’s market, as investors weigh uncertainties surrounding the U.S. Presidential election and a federal relief package, they may be viewing these as temporary hindrances. The more serious concern is the uncertainty of success in the development of a COVID-19 vaccine.

Recessions and Market Bottoms

History shows that recessions don’t necessarily spell doom for stocks. Since the end of World War II, there have been 11 U.S. recessions (counting the 1980-82 downturn as two). In each of these, stocks bottomed out before the recession ended. And in seven of the 11, stocks finished the recession higher than before it began (see Figure 1).

In four of the 11 recessions, however, the market finished lower. That is, in the four worst recessions – 1970, 1974-75, 1981-82 and 2008-09 – the market declines were more severe, and the bottom tended to occur toward the recession’s end.

 

Figure 1: Stocks Finished Higher in Seven of 11 Post-WWII U.S. Recessions

Historically, stocks have bottomed before the end of the recession.

Source: Bloomberg, National Bureau of Economic Research, Lord Abbett. Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only, and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

Even in a Double-dip, Stocks Can Fully Rebound

Double-dip recessions, which are not unusual, don’t necessarily present a reason for concern. Of the 11 post-WWII U.S. recessions, seven were double dips, posting a quarter of positive economic growth in the middle of the downturn.

Though all of the largest stock market declines associated with recessions during this period took place during these seven, in four of these, stocks finished higher. As Figure 2 shows, stocks were higher at the end of the second dip than they were prior to the first one.

How the market performs depends on the nature and extent of the downward economic pressure, with declines worsening if this pressure persists. For example, in the 1974-75 recession, the rise in oil prices that shocked the economy continued late into the decade. In the 1980/1981-82 recession (viewed as a double dip), the U.S. Federal Reserve (Fed) repeatedly tightened monetary policy, and in 2008-09, the Lehman Brothers1 meltdown was followed by the broader financial crisis.

In three of the seven double dips, markets continued to decline, and this was because it was not clear when the recession would end. But in four of the seven, the recession dynamic stabilized and downward pressure eased, allowing markets to rebound.

 

Figure 2: In Four of Seven Double-Dip U.S. Recessions, Stocks Have Finished Higher

Double dips have also seen the largest market declines.

Source: Bloomberg, National Bureau of Economic Research, Lord Abbett. Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only, and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

Risks in the Current Environment

Today, the U.S. market is weighing three primary risks: the election, the relief package and the prospects for a vaccine. Of these, the first two are likely to be resolved quickly.

As with many elections, uncertainty rises ahead of the vote and eases when the vote is tallied. Even the heightened uncertainty arising from concerns about COVID-19 and mail-in ballots is likely to be resolved quickly.

Similarly, the market realizes that any difficulties in the passage of a relief package by Congress are likely to result merely in a delay, not a cancellation. Although if the legislation does not occur until next year, there is some danger that a double-dip recession could follow.

The primary risk, however, is on the COVID-19 front. The market appears to be assuming successful development of a vaccine by the end of the year and wide availability by mid-2021. And there is reason to believe this will happen. Many resources are being devoted to the vaccine, and four candidate drugs are in stage-three trials. In addition, some candidates are already in production, so that distribution can occur quickly if the trials prove successful.

If these stage-three trials fail, however, a double-dip recession may be unavoidable. This, not a delay in U.S. election results or in the relief package, is the real risk facing investors.

On the Upside

Investors may be looking past the uncertainties of the U.S. election and Congress’ relief package because of the market’s earnings momentum. The magnitude of U.S. analysts’ revisions in their earnings estimates — direction and breadth of changes in company earnings estimates — is extraordinarily positive. This means analysts are picking up information from the companies themselves, among other sources, that implies that the negative impact from COVID-19 related issues has not been as bad as feared. If a vaccine is not developed as expected, however, these estimates would see significant downward revisions.

 

Figure 3: Near-term U.S. Earnings Momentum Is Extremely Strong

The magnitude of revisions in analysts’ earnings estimates has soared.

Source: JP Morgan, The Earnings Landscape. October 2, 2020. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

Summing Up

In a recession, stocks typically anticipate the eventual economic recovery, rebounding and often surpassing their pre-recession level even before the downturn has ended. In all 11 post-WWII U.S. recessions, the stock market hit bottom before the recession ended. In seven of 11, stock prices finished higher than they were at the recession’s start. Even in a double dip, markets can look ahead to recovery and finish higher.

Given the uncertainties surrounding the U.S. election, the federal relief package and a COVID-19 vaccine, investors are understandably concerned about the economy. But it seems that regarding the stimulus package and the election, the market is viewing these potential setbacks as only temporary.

The development of a vaccine, however, remains a wild card. Failure could lead to a double-dip U.S. recession and another market downturn. But even in this case, history has shown that stocks bottom before the recession ends. And, even in a double dip, if investors can see light at the end of the tunnel, stocks can recover even more fully.

 

1 Lehman Brothers was a U.S. financial firm that declared bankruptcy due mainly to their exposure to the subprime mortgage crisis which triggered the broader global financial crisis of 2008

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Moreover, the specific collateral used to secure a loan may decline in value or become illiquid, which would adversely affect the loan’s value. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Lower-rated bonds may be subject to greater risk than higher-rated bonds. Investing in international denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. The securities markets of emerging countries tend to be less liquid, especially subject to greater price volatility, have a smaller market capitalization, have less government regulation and may not be subject to as extensive and frequent accounting, financial and other reporting requirements as securities issued in more developed countries.

No investing strategy can overcome all market volatility or guarantee future results. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.  If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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