Economist Ezra Solomon once wrote, “The only function of economic forecasting is to make astrology look respectable.”¹ While trying to predict economic outcomes that depend on the activities of millions of people affected by hundreds of issues isn’t simple or straightforward, that hasn’t ever stopped economists from trying.

For the past year, economists have been debating whether the U.S. economy is headed for recession (an economic downturn), a soft landing (continued economic growth as inflation drops), or no landing (continued economic growth and elevated inflation). In February, Bloomberg’s survey of economists put the odds of a recession in the next 12 months at 60%.²

No matter what lies ahead in 2023, it’s important to understand what a recession is and how it may affect the stock market.

Source: Bloomberg, CIBC, as of December 31, 2020. Past performance does not guarantee or indicate future results.

A recession is part of every economic cycle
Throughout history, the U.S. economy has grown in fits and starts. We experience periods of economic growth followed by periods of economic recession. Together, an expansion and a recession complete an economic cycle.

Economic cycles, and forecasts about when they may occur, influence financial markets. In general, an expansion occurs when the Federal Reserve (Fed) lowers rates, borrowing becomes less expensive and economic growth accelerates. During expansions, company profits tend to increase. Eventually, economic growth pushes inflation higher and the Fed begins to raise rates. Then, economic growth slows, and many companies find it more difficult to grow profits. Mergers and acquisitions may become more common as companies look for ways to add value.

When a recession arrives, the level of economic output declines, risk aversion grows and credit can be more difficult to find. In general, company profits tend to decline during recessions as demand for goods and services falls. Reduced profitability can result in layoffs and lower consumer spending. Eventually, the Fed will begin to lower rates to stimulate economic growth, and recovery begins anew.

Recessions are officially identified by the National Bureau of Economic Research (NBER). The bureau defines a recession as, “…a significant decline in economic activity that is spread across the economy and lasts more than a few months.” Normally, the NBER officially identifies recessions long after they’ve ended. 

Economic cycles and the stock market
In general, stock markets rise when the economy expands and fall when the economy contracts. However, since equity markets reflect investors’ economic expectations for the future, stocks often begin to move higher before an expansion begins and lower before a recession starts.  

Specific market sectors tend to outperform during recessions, and share prices of companies in these sectors may move higher when a recession is anticipated. These sectors include:

• Consumer staples, which include companies that produce food, beverages, personal products and household goods.
• Healthcare, which includes companies that provide healthcare services, equipment and technology, and pharmaceuticals.
• Utilities, which include electric, gas and water companies.

Economically sensitive market sectors may underperform during recessions. Share prices of companies in these sectors may move lower as economic growth slows. These sectors include:

• Communication services, which encompasses telecommunications services, entertainment, and media companies.
• Real estate, which includes companies that offer real estate management and development, as well as equity real estate investment trusts.
• Information technology, which includes companies that provide equipment, software, hardware, storage, and services.

In addition, certain characteristics may help companies perform well during economic downturns. According to one analysis, 9% of publicly traded companies prospered during the recessions of 1980, 1990 and 2000, and significantly outperformed their competition. All of the companies had ample cash, modest levels of debt, and the ability to adapt to changing conditions. ³

Recessions are an important part of the economic cycle. From an investment perspective, economic downturns wring out investor exuberance and bring elevated market valuations down to more reasonable levels. As share prices fall, investors may find opportunities to buy well-positioned companies at attractive prices.

If you would like to talk about how to position your portfolio for what may be ahead, contact me at Bruce.Katz@cibc.com or 212.655.7090.

² Smith, Molly. Yoo, Kyungjin. Faster Inflation Portends Higher Fed Peak Rate in Latest Economists’ Survey. Bloomberg. February 22, 2023. Cited March 7, 2023.
³ Frick, Walter. How to Survive a Recession and Thrive Afterward. Harvard Business Review. May-June 2019. Cited March 7, 2023.