Tuesday, October 16, 2018

Stock Prices and Recessions

As some of you financial wizards might be aware, we had some volatility in the US stock market recently. Those of you with some memory left will recall that the stock market tanked about ten years ago and scared even Charlie the Tuna.

Friends of my age might have a load of stocks. If stock prices fall and stay low, then our retirements are going to see fewer Mediterranean cruises. You younger folks are still building your nest eggs and will find that a poor stock market threatens your retirements too -- if not your ability to send your kids to college. So I decided to look into stock price changes. I used the S&P 500, which is an average of the prices of 500 stocks. I could have used the Dow Jones or some other index and probably would have come to similar conclusions.

Below I analyze annual changes in the S&P 500 from 1970 to 2017. Nathan is counting on his fingers right now but my calculator says that is 48 years. 48 years is a long time. The Bee Gees and Barry Manilow were top recording artists in 1970.

The goal of looking at 48 years is to give you an idea of what happened over a pretty long period -- as well as what didn't happen. In that way, you can use history to form an opinion about what might happen in the future. Of course, Nolan knows that the past is no guarantee of the future except maybe in fire engines, but if we don't use the past I am not sure how we can evaluate the future.

During the 48 years between 1970 and 2017, there were 6 recessions. The years included in those recessions are listed in the table below. Next to the year is the percentage change in the S&P 500 of that year. Some observations:
  1. These recessions occupied at least part of 12 of the 48 years.
  2. In 6 of those 12 recession years, the S&P 500 value decreased*. The largest decrease was the 38% in 2008.
  3. The smallest decrease was the 7% decline in 1990.
  4. In the 1970 recession, the S&P rose by a very small amount.
  5. In all of the 6 recessions except for 2001, there was at least one year when the S&P 500 increased in value. (For the 2001 recession, stocks fell in 2002 and 2003!) After a recession starts and the S&P declines, it usually increases in the last year of the recession. For example, the S&P rose by 32% at the end of the 73-75 recession.
  6. The S&P 500 fell in three years that were not recessions -- 1977 (-12%), 1994 (-2%), and 2015 (-1%). That means in the 36 years that were not recession years, the S&P 500 increased in 33 of those years.
  7. The S&P fell 11 times in the 48 years period – 8 times during the 12 recessions years and 3 times in the 36 non-recession years.
What do we learn from all this?
  • Stock prices fall mostly in recessions but can decline in other years too. 
  • Stock prices fall in the beginning of a recession and generally begin rising in the last year of the recession. 
  • If there is no recession, it is highly likely that stocks will not decline. 
Will the future follow the past? There is no way to know. And sadly, it is not easy to predict when the next recession will begin in the USA. But today we are not in a recession and so long as that remains true, the likelihood is that stock prices will not decline. Since they just recently decreased, the likelihood is that the decrease will be temporary.

The table includes only recession years as defined by the National Bureau of Economic Research. Stock prices come from Wikipedia.

Year     %Change
1970      0.10

1973       -17
1974       -30
1975      +32

1980      +26
1981       -10
1982      +15

1990        -7
1991      +26

2001      -13

2008      -38
2009      +23

*When I write that the market fell in a particular year, I am basing that on the change of the market index for one year relative to the previous year. The index might have fallen many times in a year but if the value of the year was higher than the previous year, it would be considered as an increase. 

10 comments:

  1. Thank you for this one, Larry! Always good to get the long-term perspective.

    Having been in the market for a while now, it is certainly not a surprise that prices forecast both a recession and the end of it.

    What I find more surprising is how hard is appears to predict even something as efficient as the US economy – unlike markets, there’s no obvious immediate feedback loop, so forecasts are in principle possible. With the wealth of data available at all sorts of frequencies, surely by now there ought be one “true” forecast (call it the Fed’s forecast ;o). Yet it is still not the case, and the divergence of views is staggering!
    Perhaps a data-based approach, eg the Atlanta Fed GDP forecast, does not capture all the intricacies in the economy… but even adding the human judgement does not seem to help that much.

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    1. Nice to hear from you Dmitri and to read your optimism about models and data. I'm afraid, that like weather forecasting, macroeconomic forecasting gets too much respect. When the weather behaves it is easy to forecast. But when it gets truly destructive it is like a butterfly in a tornado. When you really need a good macro forecast the elements work against you. The model changes, the external factors arise from nowhere, and holding on to the reins is about all you can do. I wish it weren't true...

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  2. One of the nice things to notice is that even during the sad Carter years, the market trended upward. Stay in it for the long haul.

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    1. Thanks Fuzzy. Unfortunately some folks-- old folks primarily -- may not have a very long haul. A half decade of no or slow stock price growth might be painful. For others it should be a great buy opportunity.

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  3. Conventional wisdom is that the stock market has predicted 24 of the last 17 recessions.

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  4. That's true Rage -- the stock market is not a good predictor of recessions. Note that in my post I am looking at the opposite causality -- do recessions cause stock changes? I'm not sure the record is a lot better but it is a different exercise!

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  5. Dear LSD. The data show the stock market goes up and goes down. I predict that will continue. My binge watching FoxBizNewz corroborates Dmitri’s comment of staggering divergence of views regarding the market’s future. Half predict a strong finish in ’18 and half predict a 10% to 15% drop. Half will be right and half will be wrong but I don’t know which. However, the long-term trend is up (e.g. 7% to 10% average annually since the ’29 crash) and I’m sticking with that one. I like the adage, “Bulls make money and bears make money but pigs get slaughtered.” I learned from the severe drop in 2007, the drop in February this year, and the recent drop not to panic but to guzzle Pepto Bismol even though it leaves your tongue pink.

    Will the future follow the past? Absolutely! The Tuna knows!

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    1. I have never seen a Tuna with a pink tongue. But I get your drift and appreciate the thoughts.

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    2. Today I had a double guzzle of Pepto. Yum.

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