Recession is 'Official:' Is It Time To Look Forward?

"It' easy to see -- hard to foresee." ~ Benjamin Franklin

Now that we are "officially" in a Recession, what does that mean for stocks going forward? 

Of course, no one really knows the answer to that question, and I certainly will not attempt to do so here.  What some of you may not know, however, is that, once the "recession call" is made, stocks have historically been quite close to a significant march upward.

The reason for this is that economists look backward and investors look forward.

The stock market is often referred to as a "discount mechanism." Discounting, in reference to stocks, is essentially a means of pricing the value of stocks today based upon their expected value in the future, typically six to nine months in time -- a "crystal ball," if you will, reflecting forward expectations of economic health.

In other words, much like a barometer that measures the general business and consumer confidence of our economy, stock prices today reflect our nation's general economic health six months from now. For this reason, the stock market, as measured by the S&P 500, is a component of the economic Index of Leading Indicators.

"You cannot see the mountain near." ~ Ralph Waldo Emerson

Now for some perspective:  From the high mark on October 9, 2007, to the recent low mark put in on November 20, 2008, the price movement of the S&P 500 is a 51.93% decline. Of course, we will not attempt to "call a bottom" or make any predictions here, but let's make a few observations with specific reference to data (and following table) taken from Fidelity's Market Analysis, Research & Education (MARE):

Here are the prime points, in reference to the table above, from the November 26, 2008, MARE article, "US Stocks Often Rebound During Recessions:"

The average U.S. economic recession -- defined as a period of significant decline in economic activity -- has lasted about 11 months.

Investors historically have begun anticipating a recovery in the economy and in corporate earnings prior to the end of a recession.

On average, the stock market has begun to recover about halfway through a recession, with the typical rebound being about 25% in magnitude (from market low point to end of recession).

Bear markets that have occurred during past recessions also have tended to end during those recessions (73% of the time, 8 out of 11 instances).

"Faced with the choice between changing one's mind and proving there is no need to do so, almost everyone gets busy on the proof." ~ John Kenneth Galbraithe

While it is true, as Keynes said, that "the market can remain irrational longer than you can remain solvent," it is also true that irrational investors eventually grow tired from their exhaustive behavior; the excesses of the market are diminished or removed; and the pendulum finally begins to swing in the opposite direction -- the direction of the rational investor...

Comments

[Anonymous]

Financial markets are similar to a chess game, the fact that you have observed the game for some period of time and understood how every piece on the board moves does not mean that you can predict the next move, because sooner or later you will see castle that will leave you bamboozled and you have to rethink or update your understanding.

The current great de-leveraging crisis could be that castle which will change those stock performance during recessions plots forever.

[Kent @ The Financial Philosopher]

Anonymous:

I like your chess analogy and I agree that assumptions based upon our understanding of the past are not prudent by default.

Taking your chess analogy further, it would be equally foolish to assume that the "great de-leveraging crisis could be that castle which will change those stock performance during recession plots forever."

The safest assumption to make is that human behavior never changes. Complacency and Greed will take markets to heights beyond reason while Fear and Panic will bring markets to depths beyond reason.

Keep in mind the four most dangerous words for an investor: "It's different this time..."

"The emotions aren't always immediately subject to reason, but they are always immediately subject to action." ~ William James

[David]

Hi Kent,

Some very good points about stock market cycles and how they have coincided with economic cycles in the past.

I think another good thing to study (for both traders and investors) is the nature of bear markets, especially those following long-term bull markets.

With a bit of hindsight, it seems (in the US) we are now in the process of correcting either the last cyclical bull market in shares (2003-2007), or possibly even some of the larger secular advance that started in 1982.

We might be able to correct the excess of the past few years with the kind of severe 1 or 2 year bear market that's now unfolding. But what if the market decides it needs more time to correct or slumber, ala 1990-present Japan or the 1966-1982 US market period?

I have some not-so-bearish points as well, but will wait for your reply. Thanks!

[Dr. Joe K. Reed]

Enjoy your thoughtful comments.
The Problem I have comparing this recession to past recessions is there are "No Comparisons".
The downside momentum on this recession is historically strong, therefore, unique among all the rest. This Bear is a brand new animal. See what I mean?
(dr.joe's Tech Profiteering)

[Kent @ The Financial Philosopher]

David & Dr. Joe:

I must admit that my perspective is often absent of quantitative analysis -- it is primarily logical and qualitative in nature.

I also agree that "average" is not a term to use with this economic and market cycle.

With uncertainty provoking irrational emotions and the submission to the "easy forecast" of dire economic conditions by almost every media pundit and financial blogger, I can't help but feel a bit contrarian.

My "gut feel" is that 2009 will be a positive year for stocks, but that is as far as I will go in the direction of a "forecast."

At a minimum, this market is certainly a valuable learning tool!

Thanks for the comments...

Kent

[Kent @ The Financial Philosopher]

David:

As an addendum to my previous reply to your comment, I will answer your question, "But what if the market decides it needs more time to correct or slumber, ala 1990-present Japan or the 1966-1982 US market period?"

The answer is diversification...

I believe the US economy is at the beginning of the end of its world dominance. When I post another "Where to Invest 2009," I will give more details, but essentially, I believe Emerging Markets and Micro-cap stocks are great long-term plays going forward.

Bio-technology is another area I will discuss.

Also, in the short-term, dividend-paying value stocks look compelling.

Of course, the most prudent investor will stick with the "boring" virtues of simplicity and moderation...

Thanks again for your input, as always...

[Dr. Joe K. Reed]

~ Kent ~
Thanks for your reply. You are a philosophic dude aren't you?
Your qual and quant comments reminded me of sophomore chemistry in college... that's what it was called.
Contrarian is good cause the average fellers loose their shirts in the markets.
Your "gut feel" - 2009 a positive year for stocks? You got to be kidding! Better start thinking with your cerebrum, Kent, instead of intestines.
(and I mean that kindly because I do enjoy your comments)

As far as next year goes, remember the "Trend is your Friend" and it's headed South to Earthworm City. Don't go against it.

Respectfully,
dr.joe's Tech Analysis Profiteering

[David]

Kent, thanks for your response.

I certainly know what you mean about the preponderance of dire economic forecasts. As I glance down at today's Financial Times, the headline banner contains a placard which reads "The end is nigh"; it is placed next to a headline reading: "The worst is yet to come" (a teaser for Nouriel Roubini's comment piece in today's edition).

I understand your outlook and can certainly appreciate that you have a plan to match what could be a difficult environment for stock investing. This is something I can learn from.

We can't know for sure how the stock market will fare, but I guess each person should try and follow their own plan, as they see fit!

P.S. On the side of studying past bear markets, I was going to suggest checking out some of the ideas found in Russell Napier's book, "Anatomy of the Bear". I dug up this past interview link with Napier for anyone who is interested in hearing more on this subject.

http://www.financialsense.com/Experts/2006/Napier.html

On the bull side, I'll just quickly mention that some noted investors such as Jeremy Grantham and John Hussman are also making a case for finding value in the markets at this stage of the game.

That's all I'll add, as this comment is now running longer than the original post!

[Kent @ The Financial Philosopher]

Dr. Joe:

I appreciate your follow-up. My readers certainly sharpen my mind!

As far as your observation that "the trend is your friend," I will just say that trends are temporary...

Also, when I said my "gut feel" is that stocks would be positive in 2009, I should have said, "in my mind I believe..."

Yes, you are correct, I do think with a philosophical mind. If I were to use my "cerebrum," as you suggust, it seems I would be led by my senses (brain) rather than by my thought (mind). I believe the latter, rather than the former, is a more truthful guide.

I will put forth no argument for or against stocks being higher on December 31, 2009 than on December 31, 2008.

Perhaps we can revisit this in a year to judge my "mind vs. brain" philosophy. The mind says stocks will be higher -- the brain says stocks will be lower...

"Thus even in the very example my critics produce, it is the intellect alone which corrects the error of the senses; and it is not possible to produce any case which error results from our trusting the operation of the mind more than the senses." ~ Rene Descartes

[Dr. Joe K. Reed]

~ Kent ~
Appreciate your responce. Insiteful Wisdom for sure!
I'm really glad I found your website. We share a lot of common interests. I'm a writer, thinker, learner, computer nut, and love studying the markets, same as you.
Even wrote and published a professional book once and a monthly investment newsletter too.
I also like Quotes, same as you, but mine are on the lighter side. Here are a couple of my "Favs" I thought were Clever.

"It's true that Money cannot buy Happiness. But if you have enough, you can afford your favorite kind of Misery".

"Teenagers - Persue your dreams and accomplish all your Goals Now... while you still Know Everything!"

Enjoy,
dr.joe's Tech Analysis Profiteering

PS- We must discuss the Brain vs Mind later.
PSS- Yes, I agree Trends are temporary, but So is Life. Philosophagalize that one, lol.