The IMF expects a global recession in 2020 which could be as bad as the global financial crisis (or worse), caused by Covid-19 pandemic.
There is no official definition of recession. But it often refers to a decline in economic activity, over certain periods. Most commentators and analysts use, as a practical definition of recession, two consecutive quarters of decline in a country’s real gross domestic product (GDP). Although each recession has unique features, recessions often exhibit a number of common characteristics:
· They typically last about a year and often result in a significant output cost;
· The fall in consumption is often small, but both industrial production and investment register much larger declines than that in GDP;
· They typically overlap with drops in international trade as exports and, especially, imports fall sharply during periods of slowdown;
· The unemployment rate almost always jumps and inflation falls slightly because overall demand for goods and services is curtailed
What about the stock market?
Historically, recessionary periods did give rise to some of the worst market crashes. Remember the Great Depression? The 1937 recession? The 1973-75 recession? Or the Great Recession? They caused the markets to be cut in half, or worse.
However, not every recession leads to a crash in the stock market. According to Ben Carlson, CFA, there are basically 3 tiers of market downturns that correspond to a recession. The recessions with the worst corresponding market crashes mentioned above are the first tier. These five are the most well-known crashes and the average plunge in these five instances was -59%. The early-2000s crash was more about an unwind of speculation due to the dot-com bubble, nothing to do with a severe economic downturn.
The second tier is the more run-of-the-mill bear markets:
The average retreat in the stock market during these periods was a loss of 27%. None of these recessions or corrections were all that memorable in terms of market history.
And lastly, the corrections that correspond with a recession that never even made it to the technical -20% definition of a bear market:
The average drop in these 4 recession periods was only 16%.
Since first confirmed Covid-19 case in Malaysia, our KLCI index has slumped by 15.8%. It sank below 1,300 on March 16, marking its lowest in a decade. Would it get worse? It may, or may not. We know recessions often hit the stock market, but no one can always predict the market movement rightly. Sometimes it is difficult to understand the logic behind every investment decision made by investors. For instance, on 25th March, KLCI off highs after the Government announced a two-week extension of MCO. The market seemed to be recovering in the short term:
Unlike the 2008 financial crisis that originated from the financial sector, the current economic downturn came completely from outside the financial sector. The Covid-19 pandemic is harming areas like tourism and tourism-related activities, and other economic activities like manufacturing, construction, mining and agriculture following the lockdown.
Greater profits support higher stock prices. Conversely, when economic activity slows, spending declines, profits are reduced, and stock prices fall. If there is no proper measure in tackling the economic downturn, the stock market could continue to decline with this accelerating pandemic!
1. IMF sees global recession in 2020, recovery in 2021, 25 Mar 2020, The Straits Times
2. Recession: When Bad Times Prevail, International Monetary Fund (IMF)
3. Ben Carlson, The Relationship Between Recessions and Market Crashes, https://awealthofcommonsense.com/
4. Scott Bauer, How a recession affects the stock market, https://www.investors.com/