Amid slowing economic growth and the Federal Reserve tightening monetary policy to combat inflation levels not experienced since the early 1980s, many investors believe it is likely that the U.S. is on the cusp of entering an economic recession. Our analysis looks at how the S&P 500 Index has performed during each U.S. recession since the mid-1950s.
We use data from the National Bureau of Economic Research (NBER) to identify recessions. The NBER defines a recession as a significant decline in economic activity that is spread across the economy and lasts more than a few months. The committee that determines if an economic downturn classifies as a recession uses a range of criteria to determine its start and end dates, and often does not declare that the economy is in a recession until after it has already ended.
For this analysis, we looked at data going back to 1955. From 1955 to 2020 there were 10 recessions. We calculated the maximum drawdown for the S&P 500 Index during each recession. Maximum drawdown measures the peak to trough decline at the index level. Additionally, we calculated earnings degradation at the index level, as well as price-to-earnings multiple (P/E) compression at the index level during these periods to better understand the magnitude of earnings degradation and multiple compression.
U.S. Real GDP: Year-over-year change
Sources: St. Louis Federal Reserve, NBER. Shaded areas indicate U.S. recession.
Earnings degradation, multiple compression, and S&P 500 drawdowns
The table below displays the magnitude of earnings degradation, multiple compression, and maximum drawdown for the S&P 500 Index in each of the previous 10 recessions.
Sources: Bloomberg, NBER.
On average, S&P 500 earnings decline 16.4% in recession. Notably in two of the last ten recessions, there was no decline in index earnings. In the 1973–1975 and 1980 recessions, earnings at the index level actually grew. Both of these periods had high and rising levels of inflation, which likely kept nominal earnings growing for large U.S. companies.
During the 1973–1975 recessionary period, EPS at the S&P 500 Index level increased 18.4%. During the 1980 recession, earnings increased 7.1%.
The average P/E compression was 26.0% and the S&P 500 Index multiple declined in each of the recessionary periods.
The average S&P 500 drawdown is 31.5%. The index entered a bear market (generally defined as at least a 20% peak to trough contraction) in seven of the ten periods.
Conclusion
During recessions, U.S. companies typically encounter sharp contraction in earnings, P/E multiples, and price. The last ten recessions each had drawdowns in the S&P 500 price level and P/E multiple, while earnings declined in eight of the ten recessions.
Looking at 2022, the trailing P/E ratio for the S&P 500 index has declined from a high on 12/31/21 of 24.7 to a low of 17.3 on 9/30/22; a decline of 30.0%. The max drawdown so far in 2022 (through the end of October) is 25.4%. Both approximating the sample averages.
Earnings per share growth is slowed, but it is still positive. We anticipate further earnings degradation in 2023. This is something to be mindful of as we enter 2023.
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As an expert with a comprehensive understanding of economic indicators and financial markets, let's delve into the article's key concepts surrounding the potential U.S. economic recession, the historical performance of the S&P 500 Index during recessions, and the associated metrics such as earnings degradation, P/E compression, and drawdowns.
Economic Context:
The article discusses the current economic landscape marked by slowing growth and the Federal Reserve's efforts to combat inflation, a situation not seen since the early 1980s. Investors are speculating about the possibility of the U.S. entering an economic recession.
National Bureau of Economic Research (NBER) Criteria:
The analysis relies on data from the NBER, which defines a recession as a significant decline in economic activity spread across the economy lasting more than a few months. The committee determining recessionary periods uses various criteria and often declares a recession after it has ended.
S&P 500 Performance Metrics:
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Maximum Drawdown:
- This measures the peak-to-trough decline in the S&P 500 Index during each recession. On average, the S&P 500 experiences a drawdown of 31.5%.
- Seven out of the ten recessions resulted in the index entering a bear market (a 20% or more peak-to-trough contraction).
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Earnings Degradation:
- On average, S&P 500 earnings decline by 16.4% during recessions.
- Notably, in the 1973–1975 and 1980 recessions, earnings at the index level actually grew, possibly due to high and rising levels of inflation.
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Price-to-Earnings (P/E) Compression:
- The average P/E compression during recessions is 26.0%, indicating a decline in the market's willingness to pay for each unit of earnings.
Historical Examples:
- During the 1973–1975 recession, EPS at the S&P 500 Index level increased by 18.4%.
- In the 1980 recession, earnings increased by 7.1%, both instances occurring amid high and rising inflation.
Current Scenario (2022):
- Trailing P/E ratio for the S&P 500 declined from 24.7 (on 12/31/21) to 17.3 (on 9/30/22), representing a decline of 30.0%.
- The max drawdown in 2022 (through October) is 25.4%, approximating the historical averages.
Forward-Looking Insight:
- Earnings per share growth has slowed in 2022, but it remains positive.
- The anticipation is for further earnings degradation in 2023, a point of consideration as we approach the new year.
Conclusion:
Historically, U.S. companies face significant contractions in earnings, P/E multiples, and stock prices during recessions. The article suggests that the current market conditions align with historical patterns, emphasizing the potential for continued economic challenges and the importance of monitoring these factors as we move into 2023.
It's crucial for investors to be mindful of historical trends, though past performance is not a guarantee of future results, and the investment landscape is subject to various uncertainties and risks.
