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Are Market Downturns and Recessions Connected?


Come on, for those of you who follow the market a bit much you are wondering if the recent market pullback means a recession is coming.  Those of you who didn’t even realize the market had pulled back roughly 8% (as I write this) from its high, I congratulate you for focusing on things within your control.  However, back to the original question of whether the drop in the market means a recession is coming.  I’m writing this because Ben Carlson wrote a great article trying to answer this question.Feel free to click here to see his article.  Below are some of his points and a few of my own. 

  • The Federal Reserve is raising interest rates.  This should shock no one.  We could not have a zero-rate environment forever.  Plus, they have been telling us for years they would raise rates.
  • Rising rates means borrowing money gets more expensive.  It also means the economy is doing better.
  • Borrowing costs will increase not only for individuals (mortgages and debt) but also corporations.  Yes, corporations use debt.
  • We are starting to see a slow-down in mortgage applications and stocks of homebuilders are getting beaten up quite a bit.
  • Even with rates rising, we are still well below the average mortgage rates of the last 20-30 years. 
  • Ben did a nice analysis of what the S&P500 did 12, 6 and 3 months before recessions dating all the way back to 1929.  The average returns during these respective periods were 11.6%, 1.2% and 1.0%.  The only recessions where the respective preceding returns were all negative were 1969 (before my time) and March 2001 (right when I first started seriously investing). 
  • He also calculated there have been 20 bear markets (market drops at least 20% from highs) and 27 corrections (drops between 10% and 20%) since just before the Great Depression. 
  • Of these 47 periods, 31 of them “occurred outside of a recession and didn’t happen in the lead up to a recession.”  So, 66% of the time the market has experienced a double-digit loss with no recession as the cause.

Another point about markets and recessions.  The National Bureau of Economic Research (I bet they have wild Christmas parties) is responsible for calling the start and end of a recession.  Often, by the time they declare an official recession we are on our way out as it can take them from 6 months to nearly a year to call it.And Ben’s research shows the average length of those 47 periods above was roughly 7.5 months. 

We are approaching nearly a decade of the market pretty much only going up.  Unemployment is at a roughly 50-year low and wages are finally starting to see significant increases.  However, does the recent pullback mean a recession is around the corner?Who knows.  You may have already forgotten the S&P500 was in correction territory at the start of this year.  We are overdue for one as this bull market is one of the longest on records.Again, just because we are due one doesn’t mean it will happen soon.

And Ben reminded me of one of those classic market jokes.  It is the one where the market has correctly predicted 9 of the last 5 recessions.  Oh, I bet that would kill at the NBER Christmas party!