Commentary: Don't miss the bull market of 2009

Daily Record (Rochester, NY), Jan 14, 2009 by Kevin B Murray

While it did not come as a surprise to anyone, the National Bureau of Economic Research last month officially told us we have been in a recession since December 2007.

So it would seem like a good time to see how the stock market reacted in recent recessions. While every recession is unique, past recessions may very well tell us a lot about what's in store for equity investors in the near future.

Economics 101 teaches us that a recession is a situation in which the gross domestic product sustains a negative growth for at least two consecutive quarters. By that definition, we will not be sure we are in a recession, until the fourth quarter GDP numbers are released and show (as we anticipate) that we saw negative growth in that quarter.

The National Bureau of Economic Research is the official agency in charge of declaring when the U.S. economy is in a state of recession. It defines a recession as a "significant decline in economic activity lasting more than a few months." By that definition, they told us last month, we have been in a recession for the last 12 months.

Since World War II we have had 10 recessions. The average length has been 10 months, with the longest lasting for 16 months. Since the current recession already has lasted 12 months, it is already longer than the average recession. Unless economic recovery begins before summer, this will be the longest recession since the 43- month-long Great Depression (August 1929 to March 1933). Our current recession is likely to peter out well before it lasts even half as long as the Great Depression, however.

The depth of a recession is just as important as how long it lasts. The drop in the equity markets that coincided with the business cycle, averaged a little more than 20 percent, with the largest decline, since the Great Depression, being the more than 43 percent associated with the November 1973-March 1975 recession.

The bear market associated with the current recession has seen a greater decline with a 51 percent drop (as measured by the S&P 500) from the high in October 2007 and the low in November 2008.

As of the Jan. 9, 2009 market close, the S&P 500 is down about 43 percent from its October 2007 high. By that measure, the current recession has caused the deepest market declines since the drop associated with the Great Depression.

Bear markets in equities correlate very closely in both length and depth with recessions. Using the S&P 500 as a proxy for the stock market, we see that the stock market clearly is a leading indicator of recessions. It hits a peak prior to a recession's starting, and hits bottom prior to a recession's end. Since 1950 the peak of the S&P 500 has come an average of 4.3 months before the downturn in the business cycle. Similarly the market bottom has come 4.1 months prior to the end of the recessions. If that relationship holds true for our current recession, the stock market should become bullish roughly four months before the business cycle's trough.

Those who believe the economy will bottom out in July, as a number of forecasters do, the bull market, should begin four months earlier, in March 2009.

While the S&P 500 has seen a dismal performance since October 2007, there may be light at the end of the tunnel. Look at the S&P 500's performance in the six-, 12- and 24-month periods following the last six recessionary lows, we see the index rose an average of 37.2 percent, 45.6 percent, and 52.8 percent, respectively. Someone who leaves the equity market out of fear of the recession could forego such increases.

An average increase of 37.2 percent in the first six months after a bottom is something any investor would not want to miss. Just when the economy will bottom out is arguable, but whether it will bottom out is not.

History shows that it is the period in which a recession is anticipated -- not when it is announced -- that stocks see rapid declines. Now that the recession officially is here, the worst declines are behind us. At some point, investors anticipating a future expansion will drive equity prices higher. Those who wait for economic recovery to become crystal clear may well miss out on a high percentage of anticipatory bull market returns in 2009.

In fact, the S&P 500 briefly entered bull market territory when it increased more than 20 percent -- the traditional definition of a bull market -- from Nov. 20, 2008 until earlier this month. The Dow never quite made the 20 percent increase; the S&P has slipped below it in the last week.

Other common bull market indicators -- high trading volume and computer chip stock leadership -- also have not occurred. Most analysts believe that we just saw was a brief, bear market rally. If the current recession lasts another six to eight months, the anticipatory bull market likely would begin some time between March and May.

Investors who wait to enter the equity market until the recession "officially" is over likely will miss the vast majority of gains the 2009 bull market will generate. Those who waited until the official recession declaration of December 2008 before making defensive portfolio changes incurred huge equity losses. The stock market always looks to the future in its decision making, while all too often individual investors look to the present or the immediate past when making their decisions.