Learning From Past Recessions

Our economy is stated to be in a recession. We will only know this in the future. The question is what can be learned from studying the past recessions? The Dow Jones Industrial Average was studied from 1940 to today.

Three colums are shown below: The time period, number of months from peak to trough, and % decline

Time Period/# of Months/Dow Decline (%)
1948-1949/13 months/16 % decline
1953-1954/9 months/13 % decline
1957-1958/19 months/19 % decline
1960-1961/10 months/17 % decline
1969-1970/18 months/36 % decline
1973-1976/24 months/45 % decline
1978-1980/20 months/16 % decline
1981-1982/17 months/24 % decline
1990-1991/4 months/21 % decline
2000-2001/21 months/30 % decline

The Average values are: 15 months and 26% decline
The Statistical Maximum (95% Confidence): 27 months and 50 % decline

What has happened so far during 2007-2008: Peak to trough has been 13 months and the decline has been 44 %, close to the previous record. The trough occurred on Friday October 10, 2008 at a 44% decline from the previous peak during October 2007. The October 10th trough value has been challenged twice but not broken.

The trough in price was always in the middle of the recession not at the beginning or the end. It appears as if the increase in the stock price predicted the future end of the recession.

We have a decline that is as large as what occurred during the 1973 - 1976 time period in about half the time. In fact it occured in less time than the average. What this suggests is that the magnitude of the decline in stock price was magnified by outside forces not seen before. This new outside force is the creation and proliferation of hedge funds. As hedge funds sold to cover positions the downfall was amplified.

What does this mean:

1. Now is a good time to buy stocks if you have a longer term time horizon.
2. The downturn was magnified by outside forces, such as hedge funds.
3. As hedge funds change into a buy mode the increase should also be faster than normal.
4. A trough in stocks and subsequent rebound predicts the end of a recession.

Bottom Line: Stocks are on sale and now is a good time to buy stocks if you have a longer term time horizon. While it is impossible to predict an absolute bottom, it does not appear likely that the bottom will be much lower than what we have already seen on October 10th.