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November 2008 Recessions And Bear Markets Series
The Connection Isn't As Close As You Might Think |
by Karen Varnhagen |
| Series Part 3 While the stock market is forward looking, it isn’t psychic. Many economic slumps widely anticipated by investors— and reflected in stock prices—have never materialized, or as the Wall Street joke goes: The stock market has correctly predicted ten of the last five recessions. This unsteady relationship is illustrated by the chart which shows the rise of the Dow Jones Industrial Average since the end of World War II. (This is shown on a log scale, meaning the vertical axis is based on percentage gains, not points.) The gray bars in the background show the past 11 recessions and the red line segments mark the past ten bear markets, defined as a drop of 20% or more from a previous market peak. See chart As can be seen, bear markets and recessions often have occurred in close proximity to each other—but there are exceptions. Of the ten postwar bear markets, four occurred entirely during periods of economic expansion, while another (1946 to 1949) began at the end of one recession and hit bottom in the middle of another. Four recessions (1953 to 1954, 1957 to 1958, 1960 and 1980) were not accompanied by bear markets at all, while the worst declines of the 2000 to 2002 bear market occurred after the recession had ended. There also isn’t any automatic connection between the depth and severity of a recession and the corresponding intensity of a bear market. The deep 1981 to 1982 recession, for example, was accompanied by a relatively mild bear market, perhaps because equity valuations were already depressed when the recession started. The brief 2001 recession, by contrast, took place in the middle of the deepest bear market since the Great Depression, probably because equity valuations were drastically inflated during the 1990s boom. At this point, it’s impossible to predict whether the current economic jitters eventually will lead to a recession—or how the stock market would react if they do. Much would depend on investor expectations about the seriousness of any downturn and their confidence in the long-term soundness of the U.S. and global economies. Past performance is no guarantee of future results, but history suggests that recessions, like bear markets, are short-term corrections in a longer-term rising trend. Investors who have tried to second-guess the market—for example, by exiting the stock market when they thought a recession was at hand and jumping back into the market when they thought the economy had hit bottom—often have been disappointed. For most investors, the wisest course is to develop a longterm investment strategy and stick to it, even during market corrections and economic downturns. Disclaimer: click here to read more |
Karen Varnhagen
Senior Vice President - Wealth Management Citi SmithBarney |
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