Market Not the Best of Barometers

Many economists have been saying that the stock market’s dive is a precursor to a recession. That isn’t necessarily so.

According to the Weekly Economic & Financial Commentary, a Merrill Lynch newsletter, the stock market “has predicted 19 of the last 11 recessions” since 1929. That, of course, is a tongue-in-cheek way of saying that there have been 11 recessions since the Great Depression, but the stock market dropped sharply 19 times in the same period.

“It is a good but imperfect indicator,” the newsletter said.

So what is the use of making such comparisons when they are not that valid?

“Why do people get excited when a baseball player hits .400? He has failed six out of 10 times,” said Douglas Cliggott, senior economist at Merrill Lynch. “In a lot of areas, there are not many things that bat a thousand.”

But what Merrill Lynch was really trying to do, according to Cliggott, is to “try to calm people and to allow them to realize in a historical framework that a move like this one does not guarantee a recession. One does not follow the other. While a sharp drop in the stock market raises the possibility of a recession, it does not guarantee it.”

Of the eight occasions that a major market reversal was not followed by a recession, the largest false signal occurred in 1961-62. At that time, the market declined 22% but was followed by seven years of economic expansion.

And there were other recent examples of a false recession signal. In 1983-84, the market slumped about 10%. In 1976-78, it dropped 16%. In 1966, it skidded 17%. In all cases, the economy continued to move ahead.

According to Merrill Lynch, there is also a different though less frequent type of error: The market failed to anticipate the recessions of 1946 and 1980.