Odds on a Two-Year Recession and a Three-Year Bear

Market-watching in the 21st century features real-time analysis to a degree that was the stuff of dreams even 10 years ago. The problem is that economic crises aren't likely to be resolved any faster today than they were 50 or 100 years ago.

Anyone sitting in a bedroom can get institutional-quality quotes on securities these days. Meanwhile, an array of software-based financial analytical models with extraordinary power and depth can be deployed at affordable prices. But while we're all working on 21st-century terms, the economic mess we're in is still likely to unwind at a 20th-century pace. It's worth noting too that the factors that got us into this pickle were also familiar staples in the economic crises of yore.

Yes, economists have learned a lot over the years. But even assuming that the dismal scientists running the show today are smarter, some if not all of the 21st century intelligence is offset by the magnitude of the downturn currently running wild.

As a result, patience, fortitude and a long-term outlook remain the bedrock for investment success going forward. Some things never change. Most of us will lose our heads and run for cover and reduce all risk exposures to zero. Par for the course. That leaves prospective returns all the higher for disciplined investors. That doesn't make dealing with the catastrophe du jour any easier, but then no one ever said managing risk was easy over a full business cycle.

The trouble this time around is that the cycle is meaner and nastier than usual. Unfair? Perhaps, although today's problems come after an unusual and unsustainable run of kinder, gentler cycles. Some investors are shocked, shocked at the dire turn of events. But the warning signs were there all along. The remarkable period of calm and stability on the economic front couldn't go on forever, as we opined in April 2008. The month before, we warned that recession of some sort looked inevitable. The crowd hoped for better, but irrational optimism was again dealt the hand of fate.

So, what should we expect now? The past offers a few crumbs of perspective for how to think about the current ills. Let's start by remembering that the average length of recession since 1945 has been 10 months. The previous two recessions (1990-91 and 2001) were exceptionally short and shallow, lasting a mere 8 months each. The current contraction is now in its 14th month, according to NBER, and the hope that it'll be over in the coming months is probably asking for too much.

The longest recession in NBER's database is a crushing 65 months (1873-1879). In second place is the 1929-33 downturn that clocked in at 43 months. We don't expect the current ills will last that long, although we're likely to surpass the 16-month recessions of 1973-74 and 1981-82.

For what it's worth, we expect something on the order of a 24-month contraction, which would bring the contraction to an end at the end of this year. In turn, that would comfortably make this downturn the longest — and probably the deepest — since the Great Depression. Today's news of another round of declines in housing starts and industrial production for last month doesn't offer any reason to change our view.

What does this mean for the stock market? More of the same, of course. But again, historical context offers a bit of perspective. The average bear market for the S&P 500 lasted about 15 months, according to analysis by Crandall, Pierce & Co. The longest was 3 years; the shortest a brief 3 months. At the moment, the bear market is 16 months of age, based on the S&P's peak in October 2007.

Will we get to 3 years? Maybe, although we're expecting the rout to be over by the end of the year, if not earlier. Getting from here to there, though, will deliver one hell of a bumpy ride.

In any case, we're confident that the market will bottom out ahead of the economy, assuming history's any guide. But no one should expect a quick and robust rebound, in either the stock market or the economy. Yes, this is one more cycle in a long list of downturns. But this one will last longer and cut deeper than most.

It's going to be a long year. Pace yourself.

Comments

[User 357093:]

Even though no one really knows how bad this will be or how long it will last this article is useful, if only to remind us that were not in the same mindset just six months ago and we won't be in the same mindset six months from now.

Feb 18 12:40 PM

[Roger Knights:]

"Who is this "we" here? Is it just you? Is it kind of an imperial thing?"

It's a convention--or used to be--for authors to refer to themselves thusly. I think it was called "the editorial We."

Feb 18 01:04 PM

[Ricard:]

Agreed. I'd like to know what criteria you based your 24 month prediction upon, and what criteria would change your opinion. I'd like to believe the recession will end this year, but I've found evidence suggesting such an outcome to be little more than wishful thinking - indeed, I wouldn't be surprised if someone else used as their justification your article.


On Feb 18 12:28 PM Larry House wrote:

> How did you decide on a 24-month recession? Apparently you just pulled
> it out ot thin air. There is no way ANYONE can say at this point
> how long the contraction will last. History is looking back. This
> time has some very real differences from what has happened in the
> past. You (an many others) are still trying to put the market in
> a box and say "this is the way it will be" when you have NO WAY of
> knowing. I hope you are right. I am "pacing myself" as though you
> are not.

Feb 18 01:11 PM

[beegdawg007:]

If you can see when this will end, why could you not see when it would begin! I think you're just another guy with another opinion which amounts to nothing more than a huge WAG!

Feb 18 01:20 PM

[sheople:]

24 months, huh? Well I've been telling my friends and writing the paper once in awhile for closer to 10 years. It wasn't much fun watching our manufacturing move outside the U.S. borders. It hasn't been much fun watching our border laws being ignored. With no manufacturing and an abundance of cheap labor, what could anyone possible think would happen? Until we begin to address our JOB problem (and not the government hiring everyone), nothing will be fixed whether it be two years or ten.

Feb 18 01:25 PM

[old boat guy:]

As someone with a doctorate in English I can say that calling oneself "we" is not a "convention" (an invention maybe) but a hiding behind others for support, and in this case blatently phoney,

Feb 18 01:26 PM

[Just Say Whoa!:]

We've only just begun to "deleverage":
online.barrons.com/art...

Due to the baby boomer population bubble, there will be more sellers than buyers for real estate in many states:
www.usatoday.com/money...

Add in that the number of ARM mortgage resets set to occur in 2010-2011 will exceed that of the subprimes that started this downturn...

...and it's now looking like a mere "two year recession" is a Black Swan--a possible--but highly unlikely event.

Feb 18 01:32 PM

[Jason Rines...:]

Sigh... I would attempt to educate you on gentlemen like conductBosun and expain how you just made a fool of yourself. But I have concluded the world needs people like you as a sounding board of how mankind can improve.


On Feb 18 12:08 PM bosun.j wrote:

> While the IMF and a Merrill analyst are acknowledging we're in a
> depression you seem to be blathering on about a problem that exists
> only in your mind.

Feb 18 02:05 PM

[bosun.j:]

Thank you MR. Rines.

One might point out the lack of gentlemanly behavior involved when you make a comment like the one below.

There's no shame in my game Jason. I am's what I am's and I aint's no more.

I have no pretensions of hanging out with Al Bore.

Noteworthy is your ad hominum attack rather than providing a cogent argument. Is that the way gentlemen conduct themselves in your think tank?

Chok dee Jason. Chok dee.

On Feb 18 02:05 PM Jason C. Rines wrote:

> Sigh... I would attempt to educate you on gentlemen like conductBosun
> and expain how you just made a fool of yourself. But I have concluded
> the world needs people like you as a sounding board of how mankind
> can improve.
>
>
> On Feb 18 12:08 PM bosun.j wrote:

Feb 18 02:27 PM

[Jason Rines...:]

My accuracy was very precise in my forecasting of this downturn. I would have a hard time in technical explaining how I did this. Read old comments to confirm. But I read a lot about history and downturns, really interested in how social or political behavior tied into the business cycle creates particular varying outcomes in length of downturns.

Early on I said this one really resembles 1870's. A book I read called the Era of Mean about government collusion/corruption with the railroad and banking industries seemed to fit this particular event in our time. But technology of today in packaging toxic financial products and the ability of facts to reach the public accelerated this similar event into a shorter time frame. Your forecast of how long this will take to reach a sustainable Bull market almost mirrors mine. I keep saying next Bull 2013 and be tepid compared to the Bulls of 80's and 90's. The debt of the Civil War had to be paid down before sustainable recovery and the years following the 1870's were slow growth. Lincoln focusing on paying down the debts and issuing Greenbacks intensified the depression of the 1870's in the short term, but the growth of the 1890's and early 1900's were stellar.

Will the U.S. follow the same bitter but necessary medicine? Probably, but first the same style of leadership familiar with Efficient Market that got us here were all just reelected. America may be reverting back to Save and Invest but our government is going in the opposite direction. Expect voter revolution in 2012. Google House of Representatives reelection ratios and see the long-term trend. The % of the corrupt are expunged and it takes roughly four years from start of the crisis for the citizenship to conduct research that the Rep in there own backyard may be the problem.

Feb 18 03:35 PM

[Chris B:]

"Yes, economists have learned a lot over the years. But even assuming that the dismal scientists running the show today are smarter, some if not all of the 21st century intelligence is offset by the magnitude of the downturn currently running wild."

This is by far, the most interesting question. Though it may be hard to realize right now, the big-picture history of the last 100 years has been reduced frequency of recessions, reduced severity of recessions, and reduced currency fluctuation. Look it up. The ride was much wilder and scarier for our grandparents and great-grandparents.

Of course, factors such as massive improvements to education, infrastructure, laws, banking and social conditions probably had an effect on reducing the chances or severity of economic crisis, just as they certainly had an effect on productivity and GDP growth.

Yet, I suspect that experience has taught us something about how to prevent or control recessions. The depression certainly taught us what NOT to do, and greatly altered the paradigm of Western economics. Japan's lost decade compared to Sweden's very successful early 90's bank rescue is another learning tool. Even if populist politicians do the wrong things, people who know economic history will know the right course of action. This knowledge is a form a technology. The trick is getting permission to apply it.

Even though 1,000 economists signed a petition against the Smoot-Hawley tariff during the depression, it overwhelmingly passed with massive public support. Similarly, deficit hawks and bank interests stood in the way of a significant stimulus and real reform in Japan. Lectures about deservingness and fiscal responsibility hobbled the US government's response to the depression. In 1999, the public ideologically believed that deregulation was always a good thing, so they supported the repeal of the Glass-Steagal act of 1933, which directly led to the current bank crisis. The people comitted economic suicide in each case because they didn't learn the lessons of the past.

Maybe educating the public about economic history is a more valuable function than guessing how many months the recession will last. How long the recession will last is a function of what the politicians do, which is itself a function of what the public believes about economics.

Feb 18 03:44 PM

[Alex Trias:]

A very important point. It does seem like a paradigm shift is starting to unfold. During times of great market stress, it generally does feel that the very fabric of the past is being reinvented. As an investor, looking back at previous moments in history for paradigm shifts, rather than past economic cycles, may be worthwhile indeed. Whether this analysis changes your investment approach, however, is an open question for at least two reasons: (1) the market is smarter than any one of us, and prices risks better, and (2) when the very architecture of society gets knocked down (in our case, leverage, wealth through asset-ownership as opposed to work, and consumption funded by borrowed capital), nobody without a time machine can really say how or when society will rebuild. Predicting how asset prices will react to a change in social order only complicates the task.

All that said, it's a thrilling task, so here's my take for what it is worth. We are looking, possibly, at something unfolding around the world that is without precedent, but shares some of the economic and financial flavor of post World War 1 Europe and Northern Africa, or America following the banking crisis of the late 1800s, and the Asian and Latin American currency/ debt debacles of the 1980s and 1990s. During these periods, we saw entire countries (even really big ones, like the Ottoman Empire) and political/ economic structures fall apart and get rebuilt again. In each case, asset prices in debt, real estate and equities markets suffered during the "upheaval" stage as markets repriced risk and discounted a greater level of uncertainty about the future. After the upheaval stage, markets in many asset categories improved dramatically, generally reaching new highs - particularly in the case of equities in firms that adapted to the change quickly and gained "first mover" advantages vis-a-vis the newly created opportunities.

To be sure, country-specific markets for assets can, and have been permanently wiped out, during and following periods of social change (think post Tsarist Russia, or the Japanese equities markets following the 1980s debt/ real estate bubble epoch). However, given that country-specific risks can be diversified away cheaply and with ease, that ought not concern an investor. Indeed, I doubt the marketplace would compensate an investor for assuming firm, industry, country or region-specific risk at this point and if not, these risks are of none of our concern unless we happen to be in the business of arbitraging such things.

Overall, I agree with this comment insofar as it questions the key assumptions of this article - ie., it isn't different this time around, and we're going back to the same old same old when the cycle turns. Where I may part company with the author of this comment is the practical upshot of what an investor ought to DO in the face of this very real possibility that in fact, we are at one of those once every century junctures where it ACTUALLY IS different this time. My view, in case it is unclear, is this: not much - that is, assuming you're globally diversified and own several types of asset categories. By the same token, I wouldn't bother trying to figure out when the Global Dow Jones will recover, either. For those who have more than a couple of years to invest, why would we even care how things shake out in the US this year? But for intellectual curiosity, we shouldn't.


On Feb 18 12:22 PM prudentinvestor wrote:

> This is not a recession, it is a global paradigm shift, economically,
> politically, and morally.
>
> Economically, it is the US & Europe returning to a labor-based
> rather than an asset based economic paradigm, in which people live
> within their means. Politically, it is about a resumption of the
> long-term socialist trend that was interrupted ca 1980 by Thatcher
> & Reagan. Morally, it is about the end of an era in which mindless,
> wasteful hyper-consumption, which contributes little to its perpetrators'
> well-being, is glorified.
>
> How all this affects markets and investments is yet to be discovered,
> but I doubt that the normal recession-recovery cycle of recent times
> is being replicated.

Feb 18 03:58 PM

[John Lounsbury:]

James Picerno - - -

I agree with many commenters that you should have given more discussion to the "two year recession" estimate beyond the statement: "We don't expect the current ills will last that long, although we're likely to surpass the 16-month recessions of 1973-74 and 1981-82."

What is harder for me to reconcile is the "three year bear" in the title with the statement you make: "...we're confident that the market will bottom out ahead of the economy.. ." Since, as you state. the market top was October, 2007, a three year bear would bottom in the fall of 2010. This would be 9-12 months after your estimate for the recession bottom, which is contrary to the historic tendency of the market to bottom before or at the bottom of a recession.

I guess I will take the answer from your paragraph near the end of the article: "Will we get to 3 years? Maybe, although we're expecting the rout to be over by the end of the year, if not earlier. Getting from here to there, though, will deliver one hell of a bumpy ride." Given this paragraph I guess I am questioning the wording of the title. Perhaps this title was changed by SA editors? That has happened to me, to my disappoinment.

Feb 18 04:24 PM

[Etsh:]

Your bull/bear argument is simplistic. You need to look at rolling 10 year period returns, and if you do that you plainly see we have been in a SECULAR bear market since 2000.

Feb 18 04:59 PM

[CJJ:]

I much enjoy the people who believe the US economy is forever doomed, however that an economy like China is A-OK. China is the US 30 years ago. And oh yea, the country doesn't believe in Human Rights. Sounds like a model to get behind.
Don't think China is going to assume the high point of the Worlds Economy and escape the same end game as the US or Russia or any other world leader.
I also enjoy people who believe all economies are doomed. Why even wake up in the morning?
Glad everyone is still worried about making money in the market when its obvious its glorified gambling.
Glad everyone thinks their intelligence or worth as a person comes from their investing prowess. Maybe when people realize its a big sham we can move on.
Be on the look out for the next technological breakthrough or next war. It'll have more to do with what happens in the next 20 years than all the reams of hogwash that gets written on the economy but you can't read or comment on that so have at it.

Feb 18 07:13 PM

[Moon Kil Woong:]

John, thanks for pointing out the finer points of the 3 year bear assumption.

I agree that we are basically returning to a managed society government solves all phase for the time being. I'm not sure if this is a long term paradigm shift or just the effect we see we are faced with a big recession (they all seem big at the time). Eventually, I should hope such government intrusion will subside either because of a cyclical recovery or because they obviously fail. In both cases, the recovery or the failure do not have so much to do with government action than the market correcting or not correcting itself.

The only time I see government stimulus spending as good is when the market is stuck in low gear such as the great depression. And then it must be a massive one focused on improving economic efficiency (roads, bridges, power plants, mass transit, connectivity, health care, etc.)

In the meantime, fixing shoddy bank accounting, tightening or ridding ourselves of quasi-government backed companies like Fannie Mae and Freddie Mac, regulating derivatives, preventing banks from gambling, and enforcing securities laws leaves us plenty on the table for the current administration to sort out which costs more time, effort, and political will than money.

Feb 18 11:23 PM

[Dave Wrixon:]

Frankly, looking at the Dow Jones this last couple of days, you would think that there is a false market being created in shares. To my mind there is no logical reason for the Dow to have a resistance at the November low, apart from the fact that it is deeply psychological and some powerful organization(s) don't want to see it below that level. To my mind that seems to indicate that the FED is engaged in intervention in the stock market. If that is the case, then the the value of the Dow Jones for measuring anything is screwed, and the risk of investing is greatly increased.

Feb 19 01:06 AM

[Jason Rines...:]

Just a thought here on your point: PPT, the invisible hand seemed to have been propping the market in 2008. After all, it was an election year. I believe why the Dow isn't plummeting to 5,000 or lower is the simple fact that the U.S. citizen are also investors, through there workplace of 401k's and pension funds. Those are not so easy to withdraw. Bankruptcies and decimation of those 401ks and pensions may be the catalyst driving Indexes lower but that would happen more slowly of course then panic runs of other eras.

These are some of the best comments I have ever seen out of this group. We're delving into the WHY's rather then


On Feb 19 01:06 AM Dave Wrixon wrote:

> Frankly, looking at the Dow Jones this last couple of days, you would
> think that there is a false market being created in shares. To my
> mind there is no logical reason for the Dow to have a resistance
> at the November low, apart from the fact that it is deeply psychological
> and some powerful organization(s) don't want to see it below that
> level. To my mind that seems to indicate that the FED is engaged
> in intervention in the stock market. If that is the case, then the
> the value of the Dow Jones for measuring anything is screwed, and
> the risk of investing is greatly increased.

Feb 19 11:09 AM

[Jason Rines...:]

simple technical charts

Feb 19 11:11 AM

[Dave Wrixon:]

That was my guess. Have you noticed how it always perks near the close these days? Intra-day reading mean little. The chartist don't generally use those.


On Feb 19 11:11 AM Jason C. Rines wrote:

> simple technical charts

Feb 19 02:03 PM