Future Finances Market Update
A Weekly Commentary by Max Larsen

Monday, November 17, 2008

                                       Recessions – Why it pays to know the history

It was another gut-wrenching week for the stock market as dismal economic news keeps flowing.  This from IBD: Retail Sales Dived Record 2.8% in Oct. As Job Cuts Pile On. 

 Yes, there’s little doubt in my mind we are in a recession and the economic news will continue to worsen.  But, simply because the news is bad doesn’t mean portfolios are destined to keep decreasing.  As I have repeatedly said – the stock market is a “leading indicator” while the economy is a “lagging indicator”.  Numerous studies have shown the stock market bottoms 4 to 9 months before the economy starts recovering.

 Today I want to share a little research on recessions that is worth reading.  It’s a little long but once you understand the basics – think of how much fun you’ll be at cocktail parties…

 By studying the U.S. economic recession history, you should have a better understanding of how the current recession may affect your financial life today and, hopefully, ease your fears.    The old saying “History doesn’t always repeat itself, but often rhymes”, is based more on fact than fiction – so studying a little history is important.

 Past Recessions since 1950’s

 The National Bureau of Economic Research (NBER) is the official agency that determines when recessions begin and end.  You can go on to their web-site (www.nber.com) to get all of these numbers I’m about to share.  As you are looking through the numbers please play close attention to the averages.

 

 There are a few items worth noting:

• We’ve had 9 recessions since 1950 – yes, they are a NORMAL part of our economy.
• The average recession goes on for a little over 10 months with the economy decreasing 2.4% and unemployment hitting 7.4%.
• In spite of what you read we are NOT even close to the depression numbers, e.g., 25% unemployment, the country experienced in 1929 – 1933 and 1937 – 1938.

 The Labor Department reported that our CURRENT unemployment rate increased to 6.5% from 6.1%.  That is not good but when looking at past recessions that is still low (although it will go higher).

What causes recessions? 

 That’s the million dollar question.  Unfortunately it is never one thing as John Mauldin pointed out in his weekly Thoughts from the Frontline:

Each and every recession is different from all the others and in different ways. That stands to reason, as the background economic environment was different for each one. The '70s and '80s were subject to serious levels of inflation. The recession at the beginning of this decade saw fears of deflation. Some happen with a strong dollar and some with a weaker dollar.

This recession is the result of serious bubbles in the housing and credit markets imploding. It is not the result of excess inventory or overinvestment in manufacturing capacity. As I have written numerous times, these excesses took years to build up and will take at least 2.5-3 years to correct.

How long should this recession last?

 Wouldn’t it be nice to be able to know when recessions start so you can protect your portfolio?  Yes, unfortunately the NBER is not that fast.  The official notification of the beginning of the last 4 recessions came an average of 228 days after they had begun.  This is an 8 month delay!

 Fortunately we may have found an indicator developed by the Economic Cycle Research Institute (ECRI) which has had remarkable predictive powers.  This from Chart of the Day: 

This index is a composite of several economic indicators (includes measures of production, employment, income and sales) that provides an indication as to the current state of the US economy.  Since 1950, the ECRI Coincident Index has (on average) peaked one month before the beginning of a recession (a measure by the NBER – the official arbiter of recessions) and troughed at the same time that a recession ended.  Today’s chart illustrates that the index peaked back in September 2007.  This suggests the US economy has been in recession since Q4 2007 and the recession is ongoing.

 

This is pretty interesting information.  If we entered into the recession in September 2007 we are already 13 months into it.  Remember that the longest recessions we had since 1950 were 16 months.  There are others who think we didn’t enter into recession until the start of 2008 – that would make it 10 months. 

 If, and that’s a BIG “if”, we believe these numbers then we are probably looking at the recession ending in the middle of 2009.  How can I predict this?  Once again I want to share a study done by Sam Stovall in his book S&P's Guide to Sector Rotation.  The premise of the study is as the below chart shows, the stock market (red line) has historically bottomed well before the economy (green line). 

 

My premise does assume that we hit “Market Bottom” on October 10^th.  We recently retested these lows last week and so far they have held up.

What does this tell us?

The purpose of this entire exercise is to show that waiting for the end of the recession to get back into stocks is TOO LATE!  Historically stocks start increasing 4 to 9 months before the end of the recession.  Why is that?  It’s simple - investors are buying stocks looking to the future – not the past. 

 I don’t know if we have seen the absolute bottom of this prolonged bear market, (although I think we have seen the lows for a lot of individual stocks).  Each economic, market and financial crisis is different from the previous ones.  But in their very difference, there is a commonality.  Namely, each crisis is characterized by its own new set of nonrecurring factors, its own set of apparently insoluble problems, and its own set of apparently logical reasons for well-founded pessimism about the future…

Still, we recover every time.  With the sheer amount of money being thrown at the problem by the government – I suspect we will once again…

 Also, the news will get worse before it gets better.  I suspect we’ll see unemployment hit 8–8-1/2% and TONS of bad headlines.  Yes it’s depressing reading this stuff every day but save this Market Update and re-read it to know a little history and then go have a glass of wine.

 If you’re still with me thank you for your patience.  There’s no way to make this stuff easy but as Paul Harvey is noted for saying:  “Now you know the rest of the story…”

 Have a wonderful week my friends.

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