Market’s Slump Not Too Troubling
The question is relevant now for two key reasons. The U.S. economy is suffering through a soft patch. And the stock market is a forward-looking financial-forecasting machine with a reputation for being able to predict economic events well in advance of them actually happening.
But it’s important to point out the market’s predictive ability, despite its penchant for discounting future events, is not perfect. The late Nobel Prize winning economist Paul Samuelson once quipped that the stock market had predicted nine of the last four recessions.
So what does history tell us?
In short, don’t fret the small stuff. It is rare for mild stock market corrections of 10 percent or more to foreshadow recessions, according to a study by Bank of America Merrill Lynch chief investment strategist David Bianco. Since 1928, of the 81 pullbacks of 10 percent or more that occurred when the economy was still in growth mode, only 13, or 16 percent, led to recessions within six months. And the average gain for the Standard & Poor’s 500-stock index after corrections that did not lead to recessions was 7.4 percent.
A more sinister warning signal from the stock market is when the price declines are steeper, Bianco found. Stock losses ranging from 16 percent to 21 percent “tend to predict recessions with a 1-in-2 chance,” he says. More benign corrections of 11 percent to 15 percent are less predictive, with the odds widening to 1-in-5.
The S&P 500 has fallen as much as 7.2 percent since its 2011 peak on April 29. After Thursday’s drop it was 5.9 percent below that peak.
“What’s important is that from a price decline standpoint, the market is not sending a strong signal of recession,” Bianco says.
The market has also sent “false signals” of recession in the past, adds Sam Stovall, chief investment strategist at S&P. It’s “too soon to tell” if it is signaling a recession this time.
Stovall says that since 1945 there have been 54 stock drops of 5 percent to 10 percent. “If a minor decline was all we needed to signal an impending recession, we should have had 54 recessions since World War II, rather than the 12 we actually did have,” he says. “The recessionary warning signals look a lot clearer after the fact.”
And timing the market is still tough. In the past nine recessions since 1953, but not including the Great Recession that ended in June 2009, stocks were higher at the end of the recession than at the start, Vanguard says. “It is notoriously hard to sell before a drop and buy back before a rise,” the mutual fund giant said in a report. “A common mistake people make is to sell after a fall and then miss out on a subsequent recovery.”
Copyright © 2011 USA TODAY, a division of Gannett Co. Inc., Adam Shell.
