Will the Stock Market Crash in a Recession?

Savvy investors understand that there are always good and bad times in the economy, and it appears from the recent economic commentary that we should batten down the hatches as a recession is looming. But there are two ways to look at whether a recession is good or bad both from a household and an investing perspective.

What has happened historically when Australia enters a recession?

The prospect of a recession is creating a dark cloud of doom and gloom across Australian households and the expectation of rising inflation and interest rates is placing enormous pressure on household budgets. Given this, it is understandable that a recession would not be welcome but if we look beyond this as to how recessions have affected the stock market, we get a different perspective.

Before the brief recession in 2020 that lasted over two negative quarters of GDP, Australia hadn’t experienced a recession since 1991-92. In 1991 the All Ordinaries Index rose over 29 per cent and in 1992 it fell by 6 per cent before rising over 100 per cent the following decade. Prior to 1991, we experienced a recession in 1982-83 and in 1982 the All Ordinaries Index fell just over 18 per cent before rising nearly 60 per cent in 1983 and then nearly 200 per cent into the 1987 high.

In 2020, we know the Australian stock market fell around 40 per cent in just two months before rising over 80 per cent into early 2022. Based on this data, we know that, on average, recessions last around 11 months and result in a bullish stock market.

Australia has largely avoided recessions over the last 30 years and while there is a small chance that one may occur in the near future, it won’t be long or severe. What we can learn from the data is that shares and property are likely to produce the greatest growth in the medium to longer term.

We also know that smart investors look beyond the current crisis, as they understand that a good investment strategy involves buying when the majority are looking the other way in preparation for the impending bull-run. Right now, the masses are not interested in the stock or property markets, as they are fearful, which spells opportunity for those who understand the dynamics at play.

What were the best and worst performing sectors last week?

The best performing sectors included Information Technology up 7.11 per cent followed by Financials up 4.39 per cent and Materials up 3.72 per cent. The worst performing sectors included Healthcare down 0.47 per cent followed by Consumer Staples down 0.22 per cent and Utilities up 0.54 per cent.

The best performers in the S&P/ASX top 100 stocks included Iluka Resources up 19.08 per cent followed by Block up 15.30 per cent and Wisetech Global up 11.51 per cent. The worst performing stocks included Insurance Australia Group down 4.10 per cent followed by the Lottery Corp down 2.42 per cent and Transurban down 1.96 per cent.

What's next for the Australian stock market?

Once again, we have seen that things can change quickly in our market, and more recently this has meant strong falls. However, the good news is that instead of falling, the All Ordinaries Index rose 3.15 per cent last week, which means the Australian market is now trading at levels it was four weeks ago.

But before you get too excited, the move last week was achieved on lower volumes than we have seen for most of 2022. Earlier in the week, volumes were very low, although on Friday we experienced much higher volumes yet the market closed lower than the day prior, all of which indicates a lack of support for the rise. So, while the move up last week was strong, without wanting to sound bearish, it may not be sustainable.

In addition, while the market has technically traded up over the past month, it is still too early to tell if the low of 6,581 on 20 June will hold and if the All Ordinaries Index has stopped falling. For this to occur, we need to see price rise consistently, which is contrary to what we have seen over the past month given that in two of the last four weeks it has closed lower than it opened for the week.

While the strong close last Friday was a good sign, as it indicates we will see a good move up this week, more needs to occur to allay my reservations, as I will not be convinced that a bull market is unfolding until we see the next down move. I suspect we will not need to wait too long for this to occur, as the All Ordinaries Index will fall away for one of two weeks in the next month, and how far and long it falls will tell us whether the low of 20 June will hold.

As always, I urge investors to be patient because as we continue to experience, things can change quickly and jumping in too early could result in a poor outcome.

For now, good luck and good trading.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of the bestselling and award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online.