History Lessons On Recessions
Kurt Brouwer January 14th, 2008
The R word is being bandied about quite a bit these days as many in the media and on Wall Street publicly worry about an impending recession. Thus, it makes sense to take a look at what it might mean for investors in stocks if a recession is on the way. This article from the Wall Street Journal does just that [emphasis added]:
History Lessons: Past Recessions Yield A Few Clues (Wall Street Journal, January 14, 2008, Mark Gongloff & Scott Patterson)
‘If the economy is heading into recession, as many on Wall Street fear, history may offer some clues about what that might mean for stocks.
No two downturns are alike, but a look at market performance during previous recessions gives some clues about whether the market will have a relatively smooth rebound, meaning investors should be setting themselves up for the recovery, or a long, tough slog.
In many ways, today’s situation is reminiscent of the recession of 1990-91, which featured a housing bust and piles of bad loans, which hurt banks. The Federal Reserve started cutting interest rates even before the recession began. The economic downturn was no day at the park, but it was fairly easy on stocks, which rose during the recession and managed to avoid a bear market.
Source: Wall Street Journal/Standard & Poor’s
…In the 1970s and in 2001, recessions were marked by nasty bear markets. In both cases, investors ignored the risks that were building in the market, believing that high valuations were justified, be they on houses or stocks, because prices would continue rising. The earlier recession also featured soaring energy prices…’
As you can see from the WSJ’s chart, recessions come in many different flavors, not all of which are bad for stocks. The worst periods for stocks seem to occur when the economy slides into recession at that same time that stock valuations and investors’ expectations are high. Stock valuations (particularly for technology stocks) were high at the start of the most recent recession, which began in early 2001. Thus, began the most severe stock market downturn since World War II. The severity of the 2001 recession was also significantly increased by the terrorist attacks on Sepetember 11, 2001.
Valuations were also very high back in 1973, which was the era of the Nifty 50 stocks. Those were growth companies (IBM, Xerox) that were widely-believed to be so good that they were worth very high valuations. They were to the 1970s what Dell, Cisco and Microsoft were to the 1990s. Both the 2001 recession and the 1973 recession began with high valuations for growth stocks and both were tough for stocks.
Like the 2001 recession, the recession that began in July of 1990 also was associated with a geopolitical event and a war — the Persian Gulf War that began in August of 1990 when Iraq invaded Kuwait. That invasion was preceded by months of saber-rattling by Iraq and concerns over the invasion as well as disruptions to the oil supply contributed to the recession as well as the downturn in stocks in the third quarter of 1990. That recession also was exacerbated by falling home prices much as we have seen recently (see How Big Is The Housing Bubble? and Major Turning Point? - Robert Shiller).
By January of 1991, the coalition led by the U.S. began liberating Kuwait. The recession ended soon after the swift end to the war. Overall, that recession was not particularly bad for stocks, as they had modest gains during the recession. And, 1991 was a huge year for stocks with an increase of 31%.
From a long-term economic perspective, a recession is not necessarily negative because it can inject a salutary reassessment of risk into economic decisions. Though we may not have a general economic recession, the mortgage, housing and financial sectors of the economy are experiencing a severe downturn (see Bank of America Snaps Up Countrywide and Falling Home Prices Trigger Banking Crisis).
It remains to be seen whether or not a recession is coming this year. But, this little historical discussion should hopefully point out that all recessions are not equal — equally bad for the stock market that is.
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[…] January 16, 2008 · No Comments If indeed the US is heading into a recession (which I doubt) it is important to look at past recessions and the effect they had on stocks. History Lessons On Recessions […]
A different timeframe yields dramatically different conclusions. From this week’s Barron’s:
“Measured by the S&P 500’s movements during the past nine recessions, the stock market has fallen on average of 25.60% from its peak prior to each downturn to its trough during the recession.”
http://online.barrons.com/article/SB120070189835701773.html?mod=9_0031_b_this_weeks_magazine_main&page=3
Good point. However, of the nine recessions referenced in the article four had a drop of 27% or more. Five had a drop of 20% or less. The market is already down 15% from the high. So, in five of these cases, we would be at or near the bottom. I think you have to be careful with averages. For example, if a guy with a net worth of $1 walks in a room with Bill Gates, the average net worth of the room is $25 billion. However, the average net worth fell by 50% when he walked in. The point is that averages comprising nine events spanning 50 years do not mean a whole lot today.
The market discounts the future. The WSJ article draws misleading conclusions that recessions aren’t always bad for stocks because the authors only look at returns DURING the recession, completely ignoring what happened just beforehand.
The same thing is happening today. The market is discounting a recession, but the damage to stock prices may be done by the time the economists conclude that we’re in one (which we are). To say that the recession had no negative impact on stock prices would be clearly erroneous.