Bear Markets and U.S. Recessions

March 24, 2018

Since a peak of 26,614 on January 26, the Dow Jones Industrials fell 11.6% in two months and has thus quickly moved 58% of the way to being a bonafide bear market, with a peak to trough drop of 20% or more. The causes of this downward correction remain active depressants, leaving little reason to expect an imminent turnaround. The market had been looking technically expensive, and the DJIA is still 259% higher than its Great Recession low.

From a geopolitical standpoint, trade war tensions are just revving up. Washington political life is in turmoil. The past month saw President Trump’s Communications Director, National Economic Council Director, Secretary of State, FBI Deputy Director, and National Security Adviser leave the administration. A much more hawkish team has arrived, increasing the risks of military conflicts between the U.S. on the one hand and North Korea, Iran, or even China on the other.

Regarding economic matters, the Federal Reserve has a new chief, who is untested by crisis and therefore a source of uncertainty. Inflation worries have picked up, partly because of rising world oil prices, partly because of the more stimulative fiscal policy that seems oddly timed halfway through the economic upswing’s ninth year and with unemployment expected to drop below 4% soon, and partly because of the synchronized and maturing global economic expansion. Long-term interest rates are rising, and the U.S. 10Y-minus-2Y Treasury yield curve has narrowed to only 54 basis points.

Socially, a sense of America identity is under attack by tensions between urban and rural populations, between the generations, and between different races, classes and people with different educational training. Relations between the genders have been reexamined, and perhaps the greatest barrier to any notion of shared national mission is the polarization of political tribes. Like it or not, America First redefines what can be rightly asked of or expected from the United States by other countries. Nothing that came before including the dollar’s role in international trade and finance can be automatically assumed as a constant heading into the future.

Scarcely any economic prognosticators are talking about a U.S. recession. Perhaps a slowdown but not immediately and not a downturn. The possibility of a bear market in equities, however, seems reasonably plausible. The problem with this disconnection is the correlation of economic downturns and bear markets. So let’s take a quick look at the past sixty years of bear market history.

The S&P fell by 21.5% from August 1956 to October 1957, and the U.S. experienced a mild recession from August 1957 to April 1958. Monetary policy had tightened, and a budget surplus in 1957 was transformed into a deficit equal to 2.6% of GDP in 1959.

A 27.1% bear market saw the DOW drop 27% from December 1961 until June 1962. Less than a year previously, there had been a recession from April 1960 to February 1961.

The next bear market with the DOW dropping 25% occurred from February  to October 1966. It was associated with some Fed tightening but occurred in the middle of a prolonged economic upswing that finally ended as the 1960’s came to a close.

The ensuing recession from December 1969 until November 1970 overlapped  with a 36% decline of the DOW from December 1968 until May 1970. Spending for Vietnam and Great Society domestic programs were heating up inflation, forcing monetary tightening and efforts to trim the budget deficit.

A significant recession lasting from November 1973 to March 1975 was triggered by the first OPEC oil price shock and was associated with a 45% drop in the DOW from January 1973 to December 1974. Such gained additional momentum from the Watergate scandal.

The next bear market from September 1976 to February 1978 in which the DOW fell 27% was not associated with a recession. However, inflation accelerated from 4.9% in November 1976 to 7.0% just five months later, and the term stagflation entered the economic lexicon.

There were two recessions at the start of the 1980s, a short, aborted one from January 1980 until July 1980 and then a doozy from July 1981 until November 1982 engineered by Fed Chairman Volcker to successfully end double-digit inflation. The DOW fell 24% from April 1981 to August 1982.

The next bear market occurred very swiftly, a 36% slump between August and October of 1987. There had been no recession before, and none ensued after. But inflation had accelerated from 1.1% in December 1986 to 4.5% by October 1987, and the Fed changed chairman in August. More than half of that bear market occurred on its final day.

The next recession did not start until July 1990 and lasted for eight months. The Gulf War and oil shock that proceeded such were factors. So was a tighter monetary policy to contain the inflationary ripples of the oil price shock and rising debt.  From July 1990 until October 1990, the DOW fell 21.2%.

The 1990s came in like a lion and ended the same way. Led by the burst bubble of dot-com companies and a number of corporate governance scandals, the Dow slumped 38% from January 2000 to October 2002. The recession from March 2001 to November 2001 also encompassed the 9-11 terrorist attacks.

America’s most recent recession from December 2007 to June 2009 was also its severest since the Great Depression. An associated bear market in the Dow from October 2007 to March 2009 depressed the index by 54%. Both economy and stocks took their cue from a busted housing market, which investment industry experts said could never happen on a national scale. The subprime debt crisis went viral through the global financial system.

Market corrections, that is setbacks of at least 10% but not over 20%, can happen from old age, but the same cannot be claimed about bear markets. The examples since the 1950s have mostly occurred near recessions, and accelerating inflation and/or Fed tightening were involved in the few exceptions.

Most of the bear markets had multiple causes, or imbalances if you will. There is still some ways for share prices to fall before the current downturn qualifies as a bear. But given it’s momentum, a breach of the 20% threshold hardly seems out of the question in light of  the confluence of political chaos, the investigation into Russian meddling in the U.S. election,  and saber-rattling over trade and the development of nuclear weapons in North Korea and Iran. If the stocks keep dropping, Fed officials will likely become less cavalier about dismissing weakening share prices as a risk factor to the economic expansion.

 Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.





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