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Recessions & the stock market


tede02
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So a client of mine was surprised to hear me say that stocks don't really correlate with the economy.  There certainly is a relationship but virtually no predictive value.  This client challenged me to look back at the data, so I did.  Attached is the spreadsheet I created that turned out pretty cool.  It shows data going back to 1960 including annualized returns of the S&P500 and every market correction (defined as decline of 10% or more), bear market (decline of 20% or more) and recession.  I basically set it up in a timeline format so you can see the variable side-by-side.  Feel free to make it prettier if you're an excel whiz or just have a better idea of how to display the data. 

Recessions_and_the_stock_market.xlsx

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I have always understood that stocks are a leading indicator to the broader economy.  What your data shows is that nearly every recession is preceded by a bear or correction.  But, not every bear market leads to a recession.  The missing data bits are periods when the economy sputtered along at a slow pace after a bear or correction.  There are always glaring exceptions such as 1987. 

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I work with an economist who shows similar data to his clients and that there is no predictive value between a bear market and recessions.

 

His joke is that the stock market has correctly predicted 15 out of the last 10 recessions (or something to that effect).

 

I've been reading George Soros' book. He said sometimes the recession can be avoided by the policy makers, but normally they do not act until they see a real threat, which usually comes from a sharp decline in the stock market. Then they act and prevented the recession. So it is exactly the sharp decline in the market that PREVENTED the recession.

 

On the other hand, there are cases when the policy maker can make mistakes, or the decline of the market has blown up too many margin accounts so the recession is bound to happen before it can be cured.  :)

 

My study shows me that Soros makes most of his profit from stocks, which he doesn't get in and out frequently, but he does not disclose how he buy and hold the stocks. I suspect that he uses value investing principles as well, because he mentioned low P/E in one of his chapters. His macro bets don't make nearly as much profit, even though he became famous for that.

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Yeah, this data point as well as country stock index return and country level GDP growth levels not correlating are two of the real big things that trip investors up from time to time.  Thanks for sharing your spreadsheet.

 

I shared a version of the data you attached at my 2008 annual meeting (held in may of 2009) and clients founds it very helpful in answering "how can you be so bullish, but not think the economy will do great?". 

 

It's not so much that I think the data is predictive, but it helps to show clients that sometimes their gut reactions are wrong.... once you feel shitty, stocks are already down, competition is already down, and there is a lot of upside without much optimism baked in.  Buffett's quote about greed and fear from his 20's is still pretty apt.

 

Thanks again.

 

 

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