``The media loves a recession, because it means no slow news days for a while. Every utterance from the Fed is a headline, weekly columns write themselves (just pick two recession cliches from your cliche file and rub ‘em together), and "man in the street" interviews will always yield some nice emotional sound bites.”- John Carlton, How to Survive Excessive Recession Hand Wringing
Financial markets function as forward discounting mechanisms and could thereby serve as leading indicator for impending recessions.
According to renowned Wharton economist Jeremy Siegel in
Stocks for the Long Run, since 1948, 10 recessions in the US were preceded by a stock market decline with a lead time of 0 to 13 months or an average of 5.7 months. (It should be noted that ten stock market declines of greater than 10% in the
DJIA were not followed by a recession)-[source
wikipedia.org].
Figure 2: Economagic: S & P 500 and US Recessions
Figure 2 from Economagic validates the view of Mr. Siegel that the stock markets have historically accounted for as strong lead indicators of previous economic storms. The recessions of 1970, 1974, 1981, 1991 and the latest dot.com bust all shows of falling stock markets values (based on the S & P 500 closing prices) prior to the formal recession (shaded areas).
Moreover, since official declarations are backdated-for instance the National Bureau of Economic Research (NBER), a private non-profit organization that officially reckons of the US business cycle, in 2001 declared the US entered into a recession in March but was broadcasted only in November 2001 (BBC)-the markets have already reflected upon the gist of the downside adjustments.
The S&P 500 accounted for nearly ¾ of the losses of the entire cycle in terms of scale (peak-trough) and had been at more than 50% of the duration of the time cycle of the bear market, when the pronouncement of a recession was made.
The point is, by the time of the official recession was recognized by the NBER, the likelihood is that the markets have already reflected the meat of the losses or is in the last inning of the bear market.
Of course, we’d like to point out that ALL recessions are different in terms of underlying causes, operating conditions and effects or impacts to markets or the economy such that we can’t interpret wholly past conditions as reflective of the future. Doing so would render one guilty of simplistic thinking.
Derivatives and structured finance or the so-called "shadow banking system", technology enabled real time capital flows, "Mrs Watanabe" and the US$ 3 trillion+ per day currency trades, South-South trading, 37 years of off-Brettonwoods “gold” standard, global transmission effects by currency pegs and dollar links, globalization of trade, labor and finance, emergence of sovereign wealth funds, massive growth of current account imbalances, emerging market vendor financing of current account deficit developed economies (or nondemocratic countries financing democratic nations), offshoring/outsourcing, WIKInomics, telecommutations, hybrid electric cars, climate change, nanotechnology, biotechnololgy and etc....account for only SOME of the variables that were NOT SEEN or were NOT AS SIGNIFICANT in the PAST as it is today that will continue to revolutionize or sizably impact present conditions going forward-in terms of economic, social, cultural, financial, political, environmental and scientific spectrums.
What we can do is to simply look at these circumstances and integrate past lessons into examining the potential distributive outcomes. Assuming a replay of past conditions under the present landscape signifies as haphazard analysis or thinking at best.
Recession: The Denmark and New Zealand Experience
From the recent global slowdown we can take glimpse of how some equity markets have responded to official recessions.
So far among developing economies only Denmark (EU Business) and New Zealand (BBC) have been official casualties to the economic downdraft or has encountered an economic growth recession in a technical sense (two quarters of negative economic growth), see figure 3.
Of course, Japan, UK and some economies under the Eurozone have been widely anticipated to fall into the daisy chain category of economic recessions in the coming quarters. Such expectations have allegedly resulted to a swift change of tide as seen in the furious rally of the US dollar index.
Figure 3: Denmark’s KFX Index (left) and New Zealand’s NZ50 (right)
Although Denmark officially acknowledged a recession last July (blue arrow)-having covered two quarters from October 2007 to June 2008 (see vertical blue lines)-we can note that from the peak-trough, the KFX has lost 23% and is now down about 18% from its former highs.
What seems to be noteworthy is that the labor market seems to be tight in spite of the recession. According to Steen Bocian chief economist of Dankse Bank (highlight mine), ``For now then, low unemployment is tempering the bleakest portents for the Danish economy. However, it is important to remember that the economy has just emerged from a long period of strong economic growth which has exerted immense pressure on the labour market. Labour shortages are therefore still a big concern for many businesses, making them reluctant to let people they worked hard to recruit go, even if order books are beginning to dry up.
``So, it is probably only a matter of time before we see a rise in unemployment. Nevertheless, there is a lot of evidence to suggest that such a move may be slow in coming and unlikely to result in especially high joblessness. Anyway, rising unemployment is not necessarily a bad thing for the Danish economy in the current climate. It may sound strange to say that the economy could benefit from having more people out of work, and of course this could not stand as an end in itself. But there is no doubt that pressure on the labour market remains intense, and unemployment is well below the structural level . i.e. one compatible with stable wage and price formation in the slightly longer term.”
It is indeed peculiar to hear an economist say that “high unemployment will be good for an economy” which is frequently blamed on “inflation” when monetary policies should be more of the culprit but nonetheless the low of levels of unemployment should extrapolate to a floor to the downside momentum of the Danish economy.
The chart itself seems to croon of the same tune; the KFX appears to be exhibiting signs of a bullish “double bottom”! So the likelihood is that Denmark’s travails could be short term in nature.
On the other hand, New Zealand which also was officially declared to be in a technical recession early August (blue arrow), covering the first semester of the year (blue vertical lines), has seen its major benchmark down on a peak to trough basis of nearly 30% to presently 22% following its recent rebound.
While it would be too early to conclude if New Zealand is in the path to a confirmed inflection point, what can be noted is that based on the technical picture the NZ50 appears to be attempting for a breakout from its bear phase of the stock market cycle. The seeming “breach” from the downside channel of the NZ50, once confirmed, should demarcate such transition.
Some Asian Bellwethers Attempt To Form A Bottom
The New Zealand’s primary benchmark the NZ50 is one of the 7 Asian bourses which seem to be working towards a formative “bottom” cycle as seen in Figure4.
Figure 4: stockcharts.com: Asian Bourses Attempting To Bottom
Aside from the Phisix and Vietnam where we previously discussed in The Philippine Peso And The Phisix: With A Little Help From Our Neighbors, and New Zealand; India’s BSE (upper left window) seems to mimic the NZ50’s motion, while the Taiwan’s Taiex (upper right window), Australia’s All Ordinaries (lower left window) and Thailand’s SET (lower right window) seem to be in a tight consolidation-typical characteristics of market bottoms; albeit this is too premature to conclude since it would need to manifest more prolonged period of rangebound movement or gradual ascension).
Nevertheless as a matter of market timing and the seasonality of trends, September usually has been a critical period for the global stock market as shown in Figure 5, although as reminder, seasonal trends aren’t infallible indicators.
Figure 5: chartoftheday.com: September’s Seasonal Weakness
The US Dow Jones Industrials have tended to be weakest during September which if seasonal trends should persist, increases the odds of volatility this month considering the already frail economic environment.
And this is where it gets interesting; if Asian equity markets manage to withstand the turbulence abroad, then the chances for the “bottoming” process are likely to get enhanced going into the yearend. This implies that if the present “divergences” will be sustained from the expected infirmities in the US markets, then Asian markets could probably see a much amplified rally by the end of the year to highlight the establishment of the bottom cycle.
And going back to the current recessions of New Zealand and Denmark, the intensity and durations of such adjustments also matters. The recession’s longevity would likely be determined by the cyclicality or secularity of the present market trends relative to the domestic economic cycle. This suggests that if, for instance, Denmark’s recession had been based on economic growth ‘overheating’ than from systemic excessive overleveraging to deleveraging adjustments, then the present recession could be ‘short and shallow’ instead of an extended one. Hence the market actions should equally reflect such momentary shortcomings than a brutish bear.
Conclusion and Recommendation
Recessions are the official affirmations of the public’s expectation of statistical negative economic growth. Where the stock market signifies as a strong leading indicator, a declaration of official recession could be construed similar to the reverse analogy of “buy on rumor, sell on news”…or simply “sell the rumor, buy the news”.
So far among developed economies, only Denmark and New Zealand has entered its fold while some others have been expected to follow.
In addition, the durability and duration of a recession depends on the degree of structural or external influences on the economic and the market cycle. Read from the stock market’s perspective, in most instances, the official declaration of a recession usually marks of the last leg of the bear market cycle especially if the market’s deterioration was earlier prompted by cyclical forces. Structural led bear markets tend to extend losses overtime and in terms of depth.
Recession will probably be a problem for some Asian economies as Japan. However, interpreted from the stock market’s action, many Asian markets have been currently attempting to form a bottom which probably means that the contagion impact from the US credit crunch could be peaking unless proven otherwise. Going into the usually volatile month of September, such critical “bottom-forming” exercise could be confirmed or debunked.
If Asian markets manage to hold its standings or its present gains into September, then based on seasonal factors there is a good chance for the markets to rally going into the yearend. A rally that fortifies the technical picture seen above compounded with broader participation could formally establish the region’s transition towards the market’s “bottom” cycle and an upcoming recovery.
In the same plane, any weaknesses seen in the market this month could be seen as an opportunity to accumulate.
At the end of the day, stock markets are likely to be driven by monetary growth and credit creation, technological advances, economic and productivity growth.
