December 01, 2008

Recession is ‘Official:’ Is It Time To Look Forward?

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 nations 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:  F rom 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 lets make a few observations with specific reference to data (and following table) taken from Fidelitys 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 ones mind and proving there is no need to do so, almost everyone gets busy on the proof.

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.