Uncategorized, Weekly Update

No, the Stock Market Does Not Predict Recessions

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Published October 26, 2018


Below is a good post from Ben Carlson regarding the ability of the stock market to predict recessions. The data says the stock market is bad at such predictions, rising half or more of the time in a 3-6 month window ahead of the onset of a recession. So, if the stock market “looks ahead” by 6-9 months as we are often told it does, the market is no better than a coin flip in foreseeing recessions. It may not look ahead all that well is the point.

“As of Tuesday’s cold open, the S&P 500 is down 7.5% or so.

The Fed is hiking interest rates. Mortgage rates are rising. Homebuilder stocks are getting annihilated. The economic recovery is well into its ninth year. The unemployment rate is the lowest it’s been in 50 years.

People are asking — are the markets predicting a recession?

The old joke is that the stock market has predicted 9 out of the last 5 recessions.

Investors assume the stock market is forward-looking, so when pundits begin “reading the tea leaves” to look for clues as to what may happen next the knee-jerk reaction is to look at the direction of stocks.

Historically speaking, the stock market hasn’t gotten ahead of many recessions.

Here’s a look at the performance of the S&P 500 using the returns 3, 6, and 12 months prior to the start of every recession since the late-1920s:

Performance of the S&P 500 using the returns 3, 6, and 12 months prior to the start of every recession since the late-1920s

The lead up to March of 2001 was really the only meaningful correction that occurred before the onset of a recession and that was because of the dot-com crash which preceded the recession by around a year. Most of these other numbers look fairly run-of-the-mill and not out of the ordinary.

By my calculations, the S&P 500 has had 20 bear markets (down 20% or worse) and 27 corrections (down 10% but less than 20%) since 1928. The average losses saw stocks fall 24% and lasted 228 days from peak-to-trough.

Of those 47 double-digit sell-offs, 31 of them occurred outside of a recession and didn’t happen in the lead up to a recession.

That means around 66% of the time, the market has experienced a double-digit drawdown with no recession as the main cause.

Of those 31 which occurred outside of a recession, the losses were -18% over 154 days, on average.

We’ll have a recession at some point but odds are the stock market won’t tip us off ahead of time. In fact, most of the time people don’t even realize we’re in a recession until after it’s already begun. NBER typically gives the official word for a recession around the time they’re ending or already in the midst of a slowdown.

The recession that began in March 2001 wasn’t officially called a recession by NBER (National Bureau of Economic Research) until November 2001, the month it ended. The recession that began in the summer of 1990 wasn’t determined until the spring of 1991. And the recession that began in the summer of 1981 wasn’t called a recession until January of 1982.

I suppose it’s possible the stock market has gotten more intelligent about sniffing out an oncoming recession.

It’s also possible the stock market just freaks out from time-to-time because there are so many other variables that move the markets outside of the economy. Since the market bottomed in early-2009 alone there have been corrections of -16.0%, -19.4%, -12.4%, -13.3%, and -10.2% in the S&P 500.

Every time stocks begin to fall it feels different. And maybe this time is.

But maybe it wouldn’t be the worst thing in the world for stocks to fall outside of a recession so fundamentals can play catch up a little bit. I wouldn’t mind seeing lower valuations and higher dividend yields in an environment where people don’t lose their jobs because of an economic slowdown.”

Here at TimingCube we take our cues from the price and volume action of the market. Lately, that’s been a near non-stop drip of lower prices with the S&P 500 down 12 of 14 days recently. As we wrote last week, this downdraft appears to be largely driven by worsening global economics – the synchronized recovery idea is firmly in the past now, replaced by fears of rising interest rates while economics soften. This week at least, interest rates have pulled back as the ongoing stock slide has finally sent investors fleeing to the safety of U.S. Treasury bonds.

Historically, buying stocks right before mid-term elections has been a very winning strategy as the uncertainty clears and investors are glad to get some perceived clarity on policy direction. Will that be the case this time as well? There are certainly plenty of other factors at play right now in a bubbling cauldron of issues that investors are reading as bearish of late. The stock market currently seems to be saying that profits may have peaked while cash is now a more reasonable investment with a yield of 2%+. Investors are adjusting to this idea, which, as Mr. Carlson’s post above suggests, may ultimately prove quite wrong as the stock market often has very poor foresight.

Market Update

Stocks continued to struggle this week, crashing through major trendlines as the market correction deepened. The week began on relatively firm footing, however, with stocks putting in a mixed showing Monday on talk of market intervention by Chinese officials playing off against a debt downgrade for Italy. The Nasdaq leaders (Amazon, Apple, Facebook, Alphabet) were bought after the prior week’s slide while financials continued to get beaten down. The Nasdaq rose +0.3%. Weak results from global companies 3M (MMM) and Caterpillar (CAT) led to an early -2% market slide Tuesday. Buyers stepped in to narrow the loss to -0.5%. Weak earnings from AT&T (T) and Texas Instruments (TXN) offset a positive report from Boeing (BA) to send stocks lower Wednesday. A late afternoon plunge pushed the Dow Industrials negative for the year. Stocks finished in ugly fashion with losses ranging from -2.4% on the Dow to -4.4% for the Nasdaq. More than half of those losses were recouped Thursday. Good earnings from a wide range of companies underpinned the oversold bounce. Visa (V), Microsoft (MSFT), Ford (F), Whirlpool (WHR), and Comcast (CMCSA) all issued strong reports. The good cheer was quickly undone Friday when earnings from market leaders Amazon (AMZN) and Alphabet (GOOG) gave sellers another boost in the ‘earnings have peaked’ theme. Stocks slipped between -1% and -2%. Investors rushed to the safety of U.S. Treasury bonds to send those yields under 3.1%, reversing the rally from early in the month.

Stocks indexes failed to capitalize on an oversold bounce Thursday to end the week decidedly lower with all indexes now below their 200-day trendlines for the first time since the market correction in late 2015. The S&P 500 (SPY) ended the week -3.95% lower while the Nasdaq 100 (QQQ) slid -3.68%. Small cap stocks (IWM) slumped -3.83%.

Warm wishes and until next week.