How accurately can the stock market (as modeled by the S&P 500 Index) predict future recessions? If one charts the S&P 500 over the years and marks when recessions begin, is there any indication that the market senses it early? How accurate are the predictions? Can the market be used to prepare for downfalls? In short: somewhat, yes, very, probably not.
The Stock Market as a Forward Indicator
We know that the stock market is supposed to be a forward indicator. The very premise of stocks, as I
- Can Recessions be Predicted? (Paul B)
stated yesterday, is to give investors a share of a company’s future profits. When you buy Apple or General Electric stock, you expect to share in the future prospects and results of the company those stocks represent.
What does that mean? Basically, the ‘sum’ of all the investors in stocks, better referenced as the ‘market’, is trying to predict how future profits will look. Just like a giant group of people singing, even though some people are wildly off pitch (or prediction!), you might expect the overall group to harmonize. The stock market is commonly said to be about 6 to 9 months forward looking. Of course, that view is more of a saying than something grounded in absolute fact.
To the Charts!
Well, careful analysis of the stock market, as done by Mish at Global Economic Trend Analysis, bears out a few facts. Yes, the stock market does predict future recessions. Yes, it is somewhat accurate. However, the results are wholly unusable, due to the fact that many false signals are given off. As he points out in the article, the market crash in 1987 didn’t portend anything. That’s quite a false warning to ignore!
What does it mean for you? Unless you see something Mish missed (good luck!), it means that the stock market must be heeded but never followed religiously, especially when scouring for signs of future recessions. So, scratch the stock market off the supposed recession indicators list. Disagree? Let me know in the comments!
Disclaimer: I own some General Electric stock.
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