Your Money: Markets and recession

By Matt Solberg on January 14, 2023.

No one can accurately predict when an economy will slip into recession, but there is an adage in investing that states the stock market knows when the economy is slowing down, before anyone else does. There’s some truth in this. Financial markets move on expectations while economic data looks backward.

In fact, we usually don’t know that we’ve lived through a recession until it’s over. That’s when gross domestic product data confirms the economy contracted over two consecutive quarters, which is the definition of a technical recession. But it’s not considered an official recession until the CD Howe Business Cycle Council (CDHBCC) says it is. The CDHBCC defines an official recession as a pronounced, persistent and pervasive decline in aggregate economic activity, with broad contraction in activity across multiple industries and employment. And by then, often the economy is already in recovery.

Contrary to popular belief, financial markets don’t usually decline at the start of a recession and revive during the economy’s recovery. Remember, the markets are usually driven by what investors think is going to happen. So, if market participants believe the economy is slowing because corporate profits are down, trade flows are declining, job growth is stagnating or retail sales are weak, they will likely reduce their exposure to riskier assets like equities. And that drives the stock market down.

At a certain point the price of equities will have fallen enough that certain investors will determine the potential reward outweighs the current risk and reinvest in the equities. That drives the stock market higher.

Then as the price of equities gain, more and more investors move back into the markets, driving the stock market even higher.

It’s also important to note that not all market pullbacks are tied to recessions and ultimately, recessions have only represented minor setbacks in the stock market’s general tendency to climb higher.

Technological change, increased productivity, growing globalization, the ongoing industrialization of developing nations and other factors have propelled markets higher in the past and will likely continue doing so in the future.

While past performance doesn’t guarantee future returns, it does provide a historical perspective.