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August 2008 Recessions And Bear Markets Series
The Connection Isn't As Close As You Might Think |
by Karen Varnhagen |
| Series Part 1 Recent economic and capital markets developments have contributed to a surge in stockmarket volatility, leading some investors to worry that the odds of a recession have risen—along with the risk of a significant market downturn. Many investors are nervous because they assume an economic recession would lead to a decline in corporate profits, which would likely push stock prices down. It may sound like a plausible assumption. However, it also could be wrong. The historical record suggests the link between recessions and bear markets is not a tight one. Over the past 11 recessions (as defined by the National Bureau of Economic Research, a nonprofit research group) the Standard & Poor’s 500 Index posted an average annualized return of 12.1%—a percentage point and a half higher than the index’s 81-year annualized return. All told, market returns have been positive in seven of the past 11 recessions. Those results may seem illogical, given that recessions usually are bad for corporate profits—and sometimes very bad. Commerce Department figures show that corporate earnings have fallen in all but two of the ten recessions since World War II—with an average annualized decline of almost 10%. Standard financial theory teaches that the price of a stock should reflect the stream of earnings it is expected to produce. So, all else being equal, lower earnings should mean lower equity valuations and negative returns. But all things are seldom equal. Other factors frequently influence stock prices, even during recessions. These forces can include inflation, interest rates, nonecomonic shocks, and investor psychology. Disclaimer: click here to read more |
Karen Varnhagen
Senior Vice President - Wealth Management Citi SmithBarney |
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