Recessions and Bear Markets: A History of Inconsistencies

  • Written by David
  • February 22, 2008 at 10:26 am
  • 1
  • The article below is penned by Liz Ann Sonders, Chief Investment Strategist at Charles Schwab & Co., Inc. She presents an interesting view about recessions and the inconsistencies in defining them and determining them.

    The full article can be read by clicking here.

    Excerpts below……

    One of my favorite Wall Street anecdotes is: “The stock market has predicted nine of the last five recessions.” That’s not to suggest the market has failed as an economic indicator—quite the contrary. The stock market remains one of the best leading indicators of the economy (in both directions). And during those periods the market has been weak in anticipation of a recession that doesn’t arrive, it is quick to reverse course. Look no further than the business of forecasting and/or declaring recessions to understand why economics is considered such an imprecise science.

    With only two exceptions, no academic economists forecasted the crash of 1929 or the subsequent Great Depression. The two exceptions were Nobel Laureate Friedrich von Hayek and Ludwig von Mises, both Austrians. Are we on to something here? Should all economists add a “von” in between their names and move to Austria to improve their forecasting records?

    Seven decades have passed since then and ushered in vastly improved tools and information access. Surely we must know more today? You’d be surprised. The study of economic and market cycles … and the relationship between the two … is fascinating. It also highlights just how often conventional wisdom and seeming logic defies the trends—and how difficult the job of forecasting is.


    Let’s get the definition straight first!

    One example of conventional wisdom surrounds the actual definition of a recession. Many, including noted economists, look for two back-to-back quarters of negative gross domestic product (GDP) growth to define a recession. It’s odd that this is the accepted definition, when in fact it is not accurate.

    The National Bureau of Economic Research (NBER) is the official arbiter of recessions, and a simple query on their Web site shows that the actual definition is a little more complicated. The NBER defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale retail sales.”

    Inconsistencies

    We’ve had recessions without back-to-back negative GDP quarters (1960 and 2001); and we’ve had back-to-back negative GDP quarters that have not been declared recessions (1947). Finally, every recession in history, with the exception of 1969, was declared as starting in advance of GDP actually turning down.

    The economic indicators themselves can also be inconsistent and misleading. Some recessions are accompanied by plunging consumer confidence (1981), but some see confidence remain stable (1974). Some recessions are driven by—and exacerbate—housing downturns (today, if we have one), yet some see housing remain healthy (2001). Some recessions bring plunging employment (1990), yet some are accompanied by rising employment (1973 and 1980).

    In turn, the market behaves differently around each recession. As you can see in the table below, of the 10 recessions we’ve endured since the end of World War II, seven have been accompanied by bear markets while the other three have brought less-severe corrections. Regardless of magnitude of accompanying market decline, the majority of the corrections and/or bear markets began in advance of, or early in, each recession.

    S&P 500 Performance Around Recessions and Soft Landings

    Nobel Laureate Robert Solow once said: “It is acutely uncomfortable to have so much in macroeconomics depend on how one deals with a concept like expectations, for which there is (inevitably?) so little empirical understanding and so much room for invention.” However, uncertainty is not only normal, but pervasive, in the economy and markets. As such, expectations become a critical variable in most decisions (economic or investment). (Would someone explain that quote to me?)

    S&P 500 Performance Following Recession Lows

    Most stock market observers are aware of the sentiment effect—peak levels of optimism are often followed by corrections and vice versa. Much is the same with economic cycles: The economy typically falls into recessions not because of random shocks or crises, but because extreme optimism and euphoria is replaced by extreme pessimism and despair.

    Important Disclosures

    The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

    All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained here is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

    Past performance is no guarantee of future results.

 

1 Comment

 

  1. Pingback : From the Desk of David Gratke » Blog Archive » Managing Your Investments in these Economic Times; Five Key Points, a Detailed Look

Leave a Reply

 

Your email address will not be published. Required fields are marked *

  • Gratke Wealth, LLC is a registered investment adviser in the State of Oregon. The adviser may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Individualized responses to persons that involve either the effecting of transaction in securities, or the rendering of personalized investment advice for compensation, will not be made without registration or exemption.