Sunday, August 31, 2008

The Stock Market Improves Before The Economy

Historical data suggests the equity markets improve before the economy begins to show some economic strength. As a result, can investors afford to sit on the sidelines before they see signs of an expanding economy?

Jeremy Siegel, a professor at The Wharton School, notes in his book, Stocks for the Long Run,
"...of the 42 recessions from 1802 to the present (2002), 39 of them, or 93 percent, have been preceded (or accompanied) by declines of 8 percent or more in the total stock returns index. Historically, a bottom in the market has led a trough in the business cycle by about five months.

Investors will have little luck predicting market upturns and downturns because turning points are usually identified months [after] they’ve occurred, not beforehand. In the meantime, they’ll miss out on significant gains. From the bottom of the market to the end of the recession, the stock market has risen an average of about 24 percent (emphasis added)."
(click on chart for larger image)

Certainly there have been false signals; however, if an investor's risk tolerance and asset allocation profile calls for equity exposure, staying in the market is almost a prerequisite to achieving market beating returns. As I noted in an earlier article, Focus On The Long Run, timing the market is very difficult. If an investor is out of the market on those days when the market gaps higher, long run returns will be impacted negatively.

Don't Wait for the Clouds to Break ($)
BetterInvesting Magazine
By: BetterInvesting Editors
September, 2008


Anonymous said...

obviously one exception doesn't void the rule, but don't forget about the 2001 recession trough v 2002 equities bottom.

Anonymous said...

Pretty much all the leading economic indicators (and the stock market is one of those) have false positives. I don't know but my guess is the stock market has false positives more often than others do (it is just so much more volatile in general I would imagine it must).