Bear Markets and Recessions Take II

OK so remember that chart I put up a while back showing the magnitude of historical bear markets since 1914? Well here it is again, in case you missed it:

S&P Composite Price Index Bull and Bear Markets 1914-2008

Market Top	Index High	% Increase	Market Bottom	Index Bottom	% Decrease
10/9/2007	1565.15	101.5%	11/20/2008	752.44	-51.9%
03/24/2000	1527.46	59.6%	10/9/2002	776.76	-49.2%
07/17/1998	1190.58	304.3%	10/08/1998	957.28	-19.6%
07/16/1990	369.78	67.1%	10/17/1990	294.51	-20.4%
08/25/1987	337.89	233.1%	12/04/1987	221.24	-34.5%
11/28/1980	140.52	61.7%	08/12/1982	101.44	-27.8%
09/21/1976	107.83	73.1%	03/06/1978	86.90	-19.4%
01/05/1973	119.87	73.0%	10/03/1974	62.28	-48.0%
11/29/1968	108.37	48.0%	05/26/1970	69.29	-36.1%
02/09/1966	94.06	79.8%	10/07/1966	73.20	-22.2%
12/12/1961	72.64	86.4%	06/26/1962	52.32	-28.0%
08/02/1956	49.75	267.2%	10/22/1957	38.98	-21.6%
05/29/1946	19.25	157.7%	06/13/1949	13.55	-29.6%
11/09/1938	13.79	62.2%	04/28/1942	7.47	-45.8%
03/10/1937	18.68	131.8%	03/31/1938	8.50	-54.5%
07/18/1933	12.20	120.6%	03/14/1935	8.06	-33.9%
09/07/1932	9.31	111.1%	02/27/1933	5.53	-40.6%
09/07/1929	31.86	408.9%	07/08/1932	4.41	-86.2%
07/16/1919	9.64	60.7%	08/24/1921	6.26	-35.1%
11/20/1916	10.55	59.1%	12/19/1917	6.00	-43.1%

The big change on this chart is on the top line, where I have updated the magnitude of this current bear market with the most current numbers, including Thursday's 11-year closing low on the S&P 500. As you can see, this leaves us now down just a shade under 52% from the peak of the broader market index in the U.S., all within approximately 13 months of action on Wall Street.

Interestingly, note that this update now officially makes the bear market of 2008 the 3rd worst in magnitude in the the U.S. going back as far as we have reliable index data to measure. Back a month ago or so when I first posted this, we were looking at a top-10 bear market but not even in the top 5 of all time, but now we are squarely beyond the dot-com bubble bursting of earlier this decade as well as the blistering bear of the 1970s. In fact, this is now the worst bear market ever recorded in this country that did not occur during the Great Depression. That's something interesting for you right there isn't it? It certainly gives a solid perspective into #1 just how bad this market action has been this year,and #2 how oversold U.S. stocks really are right now at this point.

So today I wanted to analyze a question which is certainly on my mind and the minds of investors all across this country and the world these days: what is the historical relationship between the stock market and recessions? In other words, what does the market typically do during recessions, when does it peak, and when does it bottom?

Luckily, there is much data with which to study the answer to this exact question, and the answer, at least in light of the last several recessions, falls into a very discernible pattern. Let's start by taking a look at the following charts, which show the action in the broad S&P 500 index during the last six recessions prior to this one:

The vertical lines in the above charts show first the peak of the business cycle (the beginning of a recession) and then the lows of that cycle (the end of the recession). Interestingly, the broader market does not tend to peak right along with the peak in the business cycle, and then to trough right along with the bottom of the recession; rather, the market tends to anticipate both the onset of a recession (dropping before the recession begins), and then also the recovery (rising before the recession ends). Using the history of the last six U.S. recessions as a guide, you can see pretty easily from the above charts that the stock market generally starts to fall before a recession starts -- probably contributing in some small, ironically circular way to igniting the recession in the first place -- and then it tends to fall very sharply during the first stage of a recession, but then it starts to recover in the late stages of a recession before the recession has reached its bottom -- again, ironically, probably helping trigger the recovery to some degree. If you look at those charts above, you can see this pattern quite clearly in each of the last six recessions in the U.S. Stock prices fall dramatically as the economy enters a recession, which we certainly have seen once again this time around in 2008. Then, the market begins its recovery from its own bottom some short time before the economy has gotten out of a recession.

You can also see quite clearly from the above charts that, in five of the last six recessions in America, the stock market peaks a few months before the actual start of the recession and starts falling even before the recession officially begins. This is why the stock market is often said to be a leading indicator with respect to business cycles, or a good predictor of what is to come as far as economic activity in this country.

So in sum, recent history shows with surprising repetition in patterns that when an economic recession is coming, stocks in this country tend to fall dramatically before the recession and during the first half or so of the recession, followed by a relatively sharp recovery in the late stages of a recession and helping to lift the economy out of negative GDP land.

So what does all this mean with respect to the current stock market situation? Well let's look at where we're at right now. The economic recession of 2008 officially began in the third quarter of this year, as the Q3 GDP was the first quarterly GDP number to go negative (-0.3%, as reported earlier this month and in my view likely to be revised slightly lower when it is re-reported in December). Realistically, we will probably be viewed as officially turning negative in GDP sometime in August, and most definitely by September when Lehman Brothers fell and the entire financial world starting turning on its head. And let's look now at the 1-year chart of the S&P 500 index:



And there you can see the S&P 500 falling from around 1426 in May down to right around 1200 in August, just before the recession began. So, so far we're right on pattern with the noticeable drop in advance of the recession beginning in August, and now a sharp drop as the recession has begun in earnest for the past 4 or 5 months now. So the next thing we should be looking for is for the market to stop falling and eventually start recovering, somewhere around halfway through the recession as has happened in the recent past.

Most economists are predicting no economic recovery of any substance until sometime in mid-2009. I think that is a reasonable assumption. Just how strong that eventual recovery is still very much remains to be seen, and probably has a whole lot to do with what the government does to help stimulate things between the time when Barack Obama takes office in late January and next summer. But for the sake of argument, let's call this a full-year-long recession -- longer than the average, but perhaps a reasonable assumption given the massive credit bubble that has burst all over the country over the past year -- which would mean that the recession lasts from August 2008 through August 2009. If the market continues to fall until roughly halfway through the recession as has been the pattern over the six recessions immediately preceding this one, then we are looking at a market bottom sometime around January or February of 2009. In truth, the charts above show the market generally bottom either a little bit before or a little bit after the midpoint of the recession, but generally speaking, it makes sense that this market should bottom sometime around the beginning of the new year. This would coincide very nicely with Barack Obama's assumption of the presidency in late January of next year. It seems reasonable to me that the market will likely be putting in a bottom sometime between now and late January / early February, with hopefully the onset of a new beginning and the merciful end of the Bush administration sparking a nice optimism rally on Wall Street.

So if there's one glass-half-full thing to be said about the ludicrous stock market declines over the past year, it's that history shows us with somewhat shocking regularity that we are likely very close to the bottom of the current down cycle for U.S. stocks. This is true both in magnitude of the loss -- as we are now saddled with the third-largest decline in stock prices of all time in this country -- and the time until the gains resume, judging from recent history of recessions and bear markets in the U.S. Anyone with any cash who is looking to get in to the market at good, solid prices, ones which have 120 of the 500 "blue chip" stocks in the S&P 500 trading below $10 a share (the largest percentage in history, and more than double the amount of blue-chips below $10 in the last recession in 2002), should with all luck have a fairly easy time picking winners anywhere around current levels, which are not likely to continue to exist much beyond the new year if history is a good guide. I've said it before and I'll say it again -- you don't make money in the stock market by running away when everyone else is running away as well. It's kinda like poker in a way, where you generally profit from playing tight at a loose table, and loose at a tight table. With stocks, never forget the old adage: buy low, and sell high. If you can't see that this is one of those "low" times, then you are likely in need of the mostly costly eye exam you might ever fail to get.