Recessions Are Bad for Equities

In yesterday's post, "It Keeps on Coming," I noted that numerous indicators have signaled that a recession is imminent. Adding futher fuel to the contractionary fire is today's news that first quarter Gross Domestic Product came in at a much lower-than-expected 1.3%.

For equity bulls, any sign of economic weakness has been seen as a positive for stocks, based on the curiously convoluted logic that it would force the Federal Reserve to loosen monetary policy. In fact, five decades of market history suggest that recessions are, for the most part, bad for share prices, at least during the first six months -- regardless of what the Fed does.

		S&P 500 Index	Return
Start of Recession	8/30/1957	45.22
3 months	11/29/1957	41.72	-7.74%
6 months	2/28/1958	40.84	-9.69%
12 months	8/29/1958	47.75	5.59%
Start of Recession	4/29/1960	54.37
3 months	7/29/1960	55.51	2.10%
6 months	10/31/1960	53.39	-1.80%
12 months	4/28/1961	65.31	20.12%
Start of Recession	12/31/1969	92.06
3 months	3/31/1970	89.63	-2.64%
6 months	6/30/1970	72.72	-21.01%
12 months	12/31/1970	92.15	0.10%
Start of Recession	11/30/1973	95.96
3 months	2/28/1974	96.22	0.27%
6 months	5/31/1974	87.28	-9.05%
12 months	11/29/1974	69.97	-27.08%
Start of Recession	1/31/1980	114.16
3 months	4/30/1980	106.29	-6.89%
6 months	7/31/1980	121.67	6.58%
12 months	1/30/1981	129.55	13.48%
Start of Recession	7/31/1981	130.92
3 months	10/30/1981	121.89	-6.90%
6 months	1/29/1982	120.4	-8.04%
12 months	7/30/1982	107.09	-18.20%
Start of Recession	7/31/1990	356.15
3 months	10/31/1990	304	-14.64%
6 months	1/31/1991	343.93	-3.43%
12 months	7/31/1991	387.81	8.89%
Start of Recession	3/30/2001	1160.33
3 months	6/29/2001	1224.42	5.52%
6 months	9/28/2001	1040.94	-10.29%
12 months	3/29/2002	1147.39	-1.12%

So much for Goldilocks.

Comments

[Mike M]

This is interesting. I would assume that the three months before the recession is official is probably worse.

[Michael Panzner]

I haven't actually run the numbers, but I think you might be surprised. A quick visual read suggests that was probably true before 1980, but since then, the equity market has tended to peak with the economy.

[S]

Roubini has run the numbers. His work suggests, as you'd expect, that from the market peak (a few months prior to the formal start date of the recession) the market declines an average of 28%.

http://www.rgemonitor.com/blog/roubini/144686/

[praxis22]

Thanks for that, interesting link. Your last post has cemented in me the idea that bad things are going to happen soon, I shall have to talk to my adviser, though that said, I told him bad things were coming 2 years ago and he never believed me... :)

[Rich]

I agree that bad things are coming, and probably very soon. The markets are on life support. The question is where to hide the chesnuts? Where are the safe havens for assets this time? European equities? Swiss bonds? Hard gold or coins/collectibles? If this is a nasty crash, US Tresuries and bonds may not be a safe haven at all.

[Michael Panzner]

I address all of your points in my book, and I would urge you to read it if you have the opportunity. That said, I believe there will be very few hiding places in phase one of the coming unraveling, except for cash and short-term government bonds. Longer term, it gets a lot trickier, and your last sentence raises valid concerns.

[Alex Grey]

I think that the strong increase in the stock market averages is holding up consumer spending in the face of declining house prices. So we won't see a full blown recession until the stock market turns. This may seem a bit paradoxical as you would generally expect an impending recession to cause the stock market to turn.

However, the stock market can become disconnected from the economy if it is in a bubble – which I think it is. Margin debt on the NYSE it is rapidly increasing is a parabolic increase similar to what was seen in 2000 and this is the key factor driving the stock market. In fact nominal margin debt is above the peak in 2000, while margin debt indexed by the CPI and GDP (neither is ideal, best would be the value of securities on the NYSE) is approaching the 2000 peak. Furthermore, the market seems heavily dependent on increasing margin debt. The weakness in the stock market from late February -mid-March was associated with stabilising margin debt (i.e. no increase). This leads to the following chain of reasoning:
1) margin debt cannot increase in a parabolic fashion for very long;
2) spikes in margin debt have not been followed by plateaus in the data series going back to 1959 but rather declines;
3) The spikes in margin debt in 2000 and now dwarf all previous spikes;
4) 1) and 2) suggest that the stock market will turn fairly soon unless margin buyers are replaced by other buyers e.g. institutions. This seems unlikely as institutions are not likely to re-enter the market after a substantial gain driven by such a large increase in margin debt. 3) suggests that the turn could be substantial
4) When the stock market falls and it may fall precipitously, there is likely to be a strong reaction on the part of consumers who have been living fairly precariously for quite a while (first depending on home price appreciation for their savings; now switching back to dependence on the stock market).