Tuesday, May 06, 2008

Market Is A Leading Indicator Coming Out Of Recession/Economic Slowdown

The stock market tends to serve as a leading indicator heading into a recession as well as coming out of a recession. T. Rowe Price (TROW) along with Ned Davis Research note:
...on average the stock market peaked about nine months before the onset of recessions, the pattern of each recession is different. In the 1990–91 recession, for example, the market hit its high less than a month before the recession began, while stocks peaked 14.5 months before the most recent recession began in March 2001.
Not only has the market peaked, on average, nine months prior to the beginning of a recession, the market tends to recover in advance of an improving economy.
...the market bottomed on average about five months before the end of recessions, this low has ranged from just about two months before the end of the 2001 recession to more than eight months prior to the end of the 1953–54 recession.
S&P 500 performance around postwar recessions 2008
S&P 500 Performance: postwar recessions
One aspect of the market coming out of a recession is the outperformance of small company stocks relative to large cap stocks. On the other hand, going into an economic slowdown, small caps significantly underperform large cap stocks.

According to the spring edition of the T. Rowe Price Report, "For the 12-month period following the end of the last nine recessions, small-cap stocks on average provided a 24% gain compared with 17.6% for the S&P 500." Going into the slowdown though, "in 18 bear markets since the 1930s, small-cap stocks have suffered a median decline of 29% versus 21.4% for large-cap stocks."

small cap performance relative to large cap. postwar recessions
Since studies indicate it is difficult to time the market, investors should use this point in the market cycle to make adjustments to their asset allocation. The adjustments should focus on those that bring an investor's overall portfolio allocation in line with their long term objectives.

Tracking Stock Market Performance
Through Past Economic Recessions (pdf)

T. Rowe Price Report
Spring 2008

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