The Stock Market: An Excellent Predictor of U.S. Recessions

The hot financial topic of discussion at the moment is the likelihood of a U.S. economic recession. Against the background of a deteriorating economic landscape, it is not surprising that more and more commentators have begun to declare that a recession was either already underway, or is just around the corner.

A noteworthy contribution to this debate has just been offered by Asha Bangalore, Vice President and Economist at Northern Trust. Her analysis deals specifically with the movements of the S&P 500 Index just prior to, and during a recession. The leading/lagging properties of the Index, and by how much it changes during a recession, are summarized in the table below.

S&P 500 Index – peaks and troughs*

click to enlarge

Two major conclusions follow from Bangalore’s research:

1) The S&P 500 Index is a leading indicator par excellence. Since the 1950s, the Index has always peaked before the peak of a business cycle, with the 1980 business cycle being the only exception. The Index has established a trough prior to the end of a recession without exception.

2) The median percentage decline of the Index from its peak to trough was 16.9%.

By the close of the market yesterday, the S&P 500 Index was down by 9.5% from its peak in October 2007. Although the expectation of a recession has been gaining support, it does not represent a consensus view by a long shot. Using Bangalore’s analysis of the historical relationship between the stock market and economic cycle as a guide, a rough ride could be in store in the months ahead.

Comments

[billb]

themarketskeptic.com/archive/2007/11/28/...

:)

[Eric Fox]

This argument ignores all the times that the market gave a false signal of a recession. The bottom line is that it is not a good predictor. Remember the old saying - "the market has predicted 8 out of the last 5 recessions."

[SeriousBull]

As to the question of where are the markets headed, I have to say I prefer using the Average PE of the market indicator. We closed 2007 with the S&P500 at a PE of 18.8. To get back to the average from the the 1465 recent high we would expect a 18.6% decline. We are down 9.5% from this high so we have another 9.1% to go. We're halfway to a S&P 1193. Yet support is around 1230. That's my bet.