EJ
The stock slump probably is forecasting a recession, but...
Another pay site posting. Shhhhh!
Barron's Online October 12, 1998
Foggy Crystal Ball
The stock slump probably is forecasting a recession, but...
By Gene Epstein
If the recent market selloff is any guide, then there is a better than even chance that the U.S.
economy will soon be in recession. In fact, it's even possible that a recession has begun. Then
again, maybe the market has it wrong, which wouldn't be the first time. Nobel laureate economist
Paul Samuelson supposedly quipped that the stock market has anticipated eight of the past four
recessions, and his remark has been widely interpreted to mean that when it comes to such
important work, the market isn't worth heeding. Maybe try an economist instead, whose track
record is probably zero out of the past four.
But even Samuelson's estimate translates into 50-50 foresight, and the S&P 500 always has been
included in the Index of Leading Economic Indicators, which must say something about the
economics profession's respect for the market's forecasting ability. So maybe the ominous chart
on this page is worth a look.
What it's telling us is that, based on the selloff that began after the July 17 closing high on the S&P
of 1186.75, the odds of recession might currently be four chances out of seven. The word "might"
must be used here because strictly speaking, based on closing prices, we haven't yet seen a bear
market.
So far, the S&P has fallen 19.3% from high to low, and to qualify as a full-blown bear, the
slippage must run at least 20%. Still, we're close enough to the precipice to start worrying: In four
of the past seven cases of a better-than-20% drop, a recession occurred.
However, every bear market is unlike every other, and in this case, our economic impact statement
should include both good news and bad. The good news is that a bigger-than-usual piece of this
decline is probably a much-needed correction from valuations that were unrealistically high. So
maybe the impact on the real economy will be muted. The bad news is that the decline is dealing a
heavy blow to the lives and fortunes of heavily invested U.S. consumers -- what economists call a
negative wealth effect. So maybe the impact on the real economy will be disastrous.
Another piece of good news is that as recently as 11 years ago, a bear market struck and no
recession occurred.
The accompanying chart tracks the daily close on the S&P from May 29, 1952, to the present. For
those unfamiliar with the kind of graph we're using, it's what is called a logarithmic chart,
designed to highlight percentage moves instead of absolute points.
Since 1950, bear markets in stocks have occurred seven times, but
recessions have followed in only four of these instances, usually within
a year or two. With a little luck, the economy may weather the market's
latest selloff. The chart above represents a log-scale of the S&P 500,
with the shaded areas marking recessions and the arrows showing
periods since 1952 in which the market fell at least 20% from high to
low.
The arrows highlight the seven prior bear markets that have occurred since 1952. Notice that, in
each case, a dot is inserted to mark the point at which the drop passed the defining threshold of
20%.
For those old enough to remember, the worst bear of the past half-century struck on January 11,
1973, passed the 20% mark on November 27 of that year, and hit bottom on December 9 of 1974.
It produced a stomach-churning fall from high to low of 45.44%.
Maybe, not surprisingly, that particular market crash was accompanied by the severe 1973-75
recession. The grey areas mark all eight sharp economic downturns that occurred since 1952, and
by following the story from the beginning to the present, we can squeeze out all the wisdom this
chart contains.
Before each of these eight recessions, the stock market has either declined or gone into a trading
range. It never actually rose, unless we credit the slight uptrends going into the 1953-54 recession
and prior to the short-lived recession of January-July 1980.
The chart also reveals that the market always declines after a recession has actually begun, a fact
that could prove to be useful, since sometimes even the experts are blind to what's really going on.
Back in August 1974, then-Fed Chairman Arthur Burns was publicly denying that an economic
downturn was under way, even though the history books say one had started in November of the
preceding year.
And the current Fed chief, the omniscient Alan Greenspan, was in similar denial as of September
1990, a good two months after the 1990-91 recession had begun. The stock market declines that
were quite evident in both instances might have provided a useful corrective to such empty
assurances. Given this history, the current selloff on Wall Street is at least alerting us to the
possibility of trouble.
But still, it's always helpful to know exactly how far a decline has to go before it warrants a cry of
"all hands on deck; man the lifeboats." And here the lessons of the past get a bit fuzzy.
Two of the four bear markets that did accompany recessions were practically over by the time a
20% drop had occurred. The 1981-82 recession was the very worst since the Great Depression,
and yet the bear market that accompanied it hadn't officially formed until June 1982, just six
months before the economy bottomed out. In fact, only the bear of 1973-74 was truly on the
money, forming itself by November '73 -- the very month the recession began, even though the
event didn't enlighten Fed Chairman Burns.
Today, however, given the near-bear experience of a 19.3% decline, we do have fair warning. Of
the three out of seven bear markets that proved to be false signals, two struck in the 1960s.
The first, from December 1961 to June '62, sent a colossally wrong signal, since it came at the
beginning of the longest peacetime expansion of this century. The second, from January to October
1966, at least had the virtue of occurring in the midst of an expansion that was markedly slowing.
The third false signal was of more recent vintage, accompanied by the worst one-day crash since
1929 -- the Black Monday of October 19, 1987, when the market fell more than 20%. From the
August 20 high to the October 26 low, the full decline ran 32%, and yet the economy continued to
grow until well into 1990.
But there still is some logic to the idea that a bear market helps anticipate a recession.
Why? The respectful theory is that the market somehow reflects the rich reservoir of knowledge
that comes from all those securities analysts scrutinizing the earnings prospects of all those
companies. But the trouble is that, during this downtrend at least, analysts' forecasts seem to
follow the market rather than lead it. Right now, according to the tracking firm First Call, the
bottom-up forecast on the S&P for the third quarter is running negative 3.3% versus a year ago,
which is probably in the ballpark. But for the current quarter, the analysts are posting a positive
8.1% -- and for the first quarter of 1999, 13.4%. First Call's research director, Charles Hill,
confidently predicts that, as reporting periods draw near, reality will set in, and these percentages
will start to decline.
The alternative hypothesis for the merits of the market as leading indicator is more convincing.
First, there's the negative wealth effect, as noted above. Never have so many Americans had so
much money in stocks, and if the market continues to slump, consumption will suffer. Second, a
market decline hurts consumer confidence, which also weighs on consumption. Much of the recent
decline in confidence is probably market-related.
The main source of hope for staving off recession is that Greenspan has ample cushion to ease
interest rates and seems determined to do so even before he sees the whites of a recession's eyes.
Let's hope he shoots straight -- and that this time around, the stock market's implicit forecast
proves to be as wrong as it sometimes has been in times past.
![]()
Barron's Online October 12, 1998
Foggy Crystal Ball
The stock slump probably is forecasting a recession, but...
By Gene Epstein
If the recent market selloff is any guide, then there is a better than even chance that the U.S.
economy will soon be in recession. In fact, it's even possible that a recession has begun. Then
again, maybe the market has it wrong, which wouldn't be the first time. Nobel laureate economist
Paul Samuelson supposedly quipped that the stock market has anticipated eight of the past four
recessions, and his remark has been widely interpreted to mean that when it comes to such
important work, the market isn't worth heeding. Maybe try an economist instead, whose track
record is probably zero out of the past four.
But even Samuelson's estimate translates into 50-50 foresight, and the S&P 500 always has been
included in the Index of Leading Economic Indicators, which must say something about the
economics profession's respect for the market's forecasting ability. So maybe the ominous chart
on this page is worth a look.
What it's telling us is that, based on the selloff that began after the July 17 closing high on the S&P
of 1186.75, the odds of recession might currently be four chances out of seven. The word "might"
must be used here because strictly speaking, based on closing prices, we haven't yet seen a bear
market.
So far, the S&P has fallen 19.3% from high to low, and to qualify as a full-blown bear, the
slippage must run at least 20%. Still, we're close enough to the precipice to start worrying: In four
of the past seven cases of a better-than-20% drop, a recession occurred.
However, every bear market is unlike every other, and in this case, our economic impact statement
should include both good news and bad. The good news is that a bigger-than-usual piece of this
decline is probably a much-needed correction from valuations that were unrealistically high. So
maybe the impact on the real economy will be muted. The bad news is that the decline is dealing a
heavy blow to the lives and fortunes of heavily invested U.S. consumers -- what economists call a
negative wealth effect. So maybe the impact on the real economy will be disastrous.
Another piece of good news is that as recently as 11 years ago, a bear market struck and no
recession occurred.
The accompanying chart tracks the daily close on the S&P from May 29, 1952, to the present. For
those unfamiliar with the kind of graph we're using, it's what is called a logarithmic chart,
designed to highlight percentage moves instead of absolute points.
Since 1950, bear markets in stocks have occurred seven times, but
recessions have followed in only four of these instances, usually within
a year or two. With a little luck, the economy may weather the market's
latest selloff. The chart above represents a log-scale of the S&P 500,
with the shaded areas marking recessions and the arrows showing
periods since 1952 in which the market fell at least 20% from high to
low.
The arrows highlight the seven prior bear markets that have occurred since 1952. Notice that, in
each case, a dot is inserted to mark the point at which the drop passed the defining threshold of
20%.
For those old enough to remember, the worst bear of the past half-century struck on January 11,
1973, passed the 20% mark on November 27 of that year, and hit bottom on December 9 of 1974.
It produced a stomach-churning fall from high to low of 45.44%.
Maybe, not surprisingly, that particular market crash was accompanied by the severe 1973-75
recession. The grey areas mark all eight sharp economic downturns that occurred since 1952, and
by following the story from the beginning to the present, we can squeeze out all the wisdom this
chart contains.
Before each of these eight recessions, the stock market has either declined or gone into a trading
range. It never actually rose, unless we credit the slight uptrends going into the 1953-54 recession
and prior to the short-lived recession of January-July 1980.
The chart also reveals that the market always declines after a recession has actually begun, a fact
that could prove to be useful, since sometimes even the experts are blind to what's really going on.
Back in August 1974, then-Fed Chairman Arthur Burns was publicly denying that an economic
downturn was under way, even though the history books say one had started in November of the
preceding year.
And the current Fed chief, the omniscient Alan Greenspan, was in similar denial as of September
1990, a good two months after the 1990-91 recession had begun. The stock market declines that
were quite evident in both instances might have provided a useful corrective to such empty
assurances. Given this history, the current selloff on Wall Street is at least alerting us to the
possibility of trouble.
But still, it's always helpful to know exactly how far a decline has to go before it warrants a cry of
"all hands on deck; man the lifeboats." And here the lessons of the past get a bit fuzzy.
Two of the four bear markets that did accompany recessions were practically over by the time a
20% drop had occurred. The 1981-82 recession was the very worst since the Great Depression,
and yet the bear market that accompanied it hadn't officially formed until June 1982, just six
months before the economy bottomed out. In fact, only the bear of 1973-74 was truly on the
money, forming itself by November '73 -- the very month the recession began, even though the
event didn't enlighten Fed Chairman Burns.
Today, however, given the near-bear experience of a 19.3% decline, we do have fair warning. Of
the three out of seven bear markets that proved to be false signals, two struck in the 1960s.
The first, from December 1961 to June '62, sent a colossally wrong signal, since it came at the
beginning of the longest peacetime expansion of this century. The second, from January to October
1966, at least had the virtue of occurring in the midst of an expansion that was markedly slowing.
The third false signal was of more recent vintage, accompanied by the worst one-day crash since
1929 -- the Black Monday of October 19, 1987, when the market fell more than 20%. From the
August 20 high to the October 26 low, the full decline ran 32%, and yet the economy continued to
grow until well into 1990.
But there still is some logic to the idea that a bear market helps anticipate a recession.
Why? The respectful theory is that the market somehow reflects the rich reservoir of knowledge
that comes from all those securities analysts scrutinizing the earnings prospects of all those
companies. But the trouble is that, during this downtrend at least, analysts' forecasts seem to
follow the market rather than lead it. Right now, according to the tracking firm First Call, the
bottom-up forecast on the S&P for the third quarter is running negative 3.3% versus a year ago,
which is probably in the ballpark. But for the current quarter, the analysts are posting a positive
8.1% -- and for the first quarter of 1999, 13.4%. First Call's research director, Charles Hill,
confidently predicts that, as reporting periods draw near, reality will set in, and these percentages
will start to decline.
The alternative hypothesis for the merits of the market as leading indicator is more convincing.
First, there's the negative wealth effect, as noted above. Never have so many Americans had so
much money in stocks, and if the market continues to slump, consumption will suffer. Second, a
market decline hurts consumer confidence, which also weighs on consumption. Much of the recent
decline in confidence is probably market-related.
The main source of hope for staving off recession is that Greenspan has ample cushion to ease
interest rates and seems determined to do so even before he sees the whites of a recession's eyes.
Let's hope he shoots straight -- and that this time around, the stock market's implicit forecast
proves to be as wrong as it sometimes has been in times past.
Thursday...ended up with 41 of those pups
Gollum's Rattlesnake market could be a Humdinger
Just a thuoght...Chicken man...