Stock Market Reaction to Recessions and Buying the Dips

Abstract

Using monthly stock-market data covering 150 years from 1871–2021, this article estimates the stock market’s reaction to recessions and analyzes whether recessions create buying opportunities. The stock market has overreacted to recessions. The overreaction is of large magnitude and fairly consistent. Buying stocks at the trough price, therefore, would produce a large above-normal return. Buying the dips based on a simple percentage-drop rule, however, fails to produce an above-normal return, because the peak-to-trough decrease in stock prices reflects enough market fundamentals to deny an easy profit. Whether a more sophisticated trading strategy can produce a sizable and consistent profit is an open question.