Happy days may not quite be here again, but they are on the way. At least that is how some interpret last week’s good economic news.
One index showed consumer confidence increased in April. The stock market is up 20 percent from lows hit four weeks ago. The latest tally of new claims for unemployment came in below consensus predictions. Wells Fargo predicted it would have record profits for the first quarter of 2009 and its CFO said “we are seeing a lot of business.” Some local Realtors report burgeoning buyer interest and competing offers on houses for the first time since 2007. We are on the road to recovery!
I hope so. The past 18 months have been bad, with unemployment rising and businesses and households tumbling into deep financial trouble. Any good news is indeed welcome.
But the old adage that “one swallow does not make a summer,” is as true for national economies as in personal life. History shows us that when nations dig themselves into deep financial holes, neither the journey down nor the journey up are smooth lines.
This time, we dug ourselves an economic open-pit mine. A few weeks of good news, or even less-bad news, does not mean that we have reached a turning point or that, as Herbert Hoover argued in 1932, “prosperity is just around the corner.”
Stock prices get more attention than they deserve in terms of what they really tell us about the economic health of a country. While one can pick out historic patterns, for example, that stock prices often begin to rise eight or ten months before a recessionary economy returns to growth, such patterns don’t have as much predictive power as many think.
To frame the question one way, identify points at which recessions bottomed out. What were the trends in stock prices around such turns? The answer is that stock prices indeed usually started to rise some months before.
Frame it another way, however and the data is less heartening. Identify times during recessions when stock prices bottomed and trended upwards. What happened to the general economy? The answer is that in many cases the economy did not improve and that many such stock market uptrends were temporary “suckers’ rallies.”
For example, gross domestic product fell 43 percent from 1929 to 1932. On Sept. 3, 1929, the Dow-Jones index hit 381.2. By July 8, 1932, it had dropped by 89 percent to 41.2. So overall, the two declined together.
But the stock market had several strong rallies. From Nov. 13 to Dec. 7, 1930, it rose 33 percent. From June 25 to Sept. 11, 1930, it rose 15 percent. The increase from Dec. 16, 1930, to Feb. 28, 1931, was 21 percent. And from its all-time low in July 1932, it rose 94 percent in just eight weeks. But then over the next five months it gave up four-fifths of that rally.
All in all, there were nine encouraging rallies between the 1929 peak and the 1932 trough and several more before the economy returned to pre-Depression output and employment levels. Even more price rallies and declines ensued before stock markets finally reattained their 1929 peaks in the 1950s.
Similar stock price patterns held in Japan in the 1990s. The Nikkei index had five big rallies in the 10 years following its 1989 peak. Two exceeded 50 percent.
Over the economically tumultuous 1960s and 1970s, U.S. stock markets sometimes rallied even as the economy slackened and dropped as the economy recovered. But, adjusted for inflation, the SP 500 stock index in mid-1982 was 40 percent below mid-1962.
If one looks at long-term graphs of unemployment rates or numbers of jobs or GDP over the last 60 years, the lines appear smooth. Recessions and recoveries are easy to pick out.
Change the scale and look at month-to-month or quarter-to-quarter changes over shorter periods and trends are much less cleanly defined. There are false recoveries in longer-term downtrends and false relapses in general uptrends. Clearly, in the midst of things, reliably identifying clear turning points is extremely difficult.
That is why the recession-dating committee of the National Bureau of Economic Research, a private economic research organization, only makes its calls retrospectively. They usually identify the beginning of a recession only when we are several months into it and don’t call the end of one until several months after it is over. And they shun attempts to identify turning points as they happen.
Good news is good news, particularly in terms of employment and even if only temporary. But eschew euphoria. My mother’s oft-repeated advice to “hope for the best but expect the worst,” may be a bit severe. But “hope for the best but don’t be surprised if the worst is not yet past,” is probably the most prudent approach right now.
© 2009 Edward Lotterman
Chanarambie Consulting, Inc.