Late to Recessions: Stocks and the Business Cycle

I find that returns are predictably negative for several months after the onset of recessions, becoming high only thereafter. I identify business cycle turning points by estimating a state‐space model using macroeconomic data. Conditioning on the business cycle further reveals that returns exhibit momentum in recessions, whereas in expansions they display the mild reversals expected from discount rate changes. A strategy exploiting this pattern produces positive alphas. Using analyst forecast data, I show that my findings are consistent with investors' slow reaction to recessions. When expected returns are negative, analysts are too optimistic and their downward expectation revisions are exceptionally high.