An economic trough is when economic activity hits a low point in its down cycle. The trough happens before the economy begins its recovery, and it tends to remain for some time before activity picks back up.
Understanding this term is especially important right now during the coronavirus pandemic, as investors are looking for a trough this summer—and if they don’t get it, stocks could sell-off.
But before we get into stocks, let’s just talk about the economy.
Economic growth rises in an expansion, with total output (GDP) rising year-over-year for many years. Then, it peaks. For example, maybe it peaks at 4% growth before it decelerates to 2% or 1%. Any imbalances in the economy then become a larger threat and can tip the economy into recession, or negative GDP growth for at least 2 consecutive quarters.
Let's say that in the trough of a recession, GDP growth bottoms at negative 3%. (In fact, it will much worse than negative 3% during the coronavirus pandemic.) But let’s say the bottom stays at minus 3% for a number of months. And when it rises to, say, negative 2%, that’s the economy recovering and heading back towards growth. Finally, that's also the validation the market is looking for, showing that stock investors were probably right to price in a recovery ahead of time.
At the end of the day, markets are forward looking. In fact, the stock market tends to begin pricing in a recession before it begins and then it prices in the recovery roughly 4 months before the trough, according to research from strategists at RBC Capital Markets and Stifel.
To see how stocks will trade in the next few months, given this info, watch the quick video above.