Stock Drops Don't Always Accurately Indicate Recession

April 3 -- Amid all the weeping and gnashing of teeth over the market's decline, here's something that might make you feel better: While it may seem like a market decline this nasty would be a sure indicator of recession, history suggests things could go either way.

In fact, it turns out that in almost half of all cases, sustained dropsin stock prices don't go hand-in-hand with a recession.

"You can have the market decline and not have the economy fall apart," says Randall Kroszner, an economics professor at the University of Chicago business school. "There's no necessary connection, though they can be connected."

According to data from the Investment Company Institute, a mutual fundtrade group, there have been half a dozen times in the last 60 years when the stock market has dropped steeply but the economy has managed to avoid veering into recession. (ICI researchers considered a decline to be at least 20 percent over three or four months, or of at least 9 percent over five months or more).

To put a precise number on an oft-misquoted phrase: Of the 14 majorstock market cycles since 1942, six were not associated withrecessions.

"The stock market predicted 14 recessions, and only eight haveactually come true," says Jim Bianco, president of Bianco Research.

Avoiding Recession

But how could there be a sustained, sizable market drop without arecession? It would seem like a bear market would forecast trouble brewing in the broader economy.

But that's not always the case. The market looks far into the future, points out Kroszner, "so a change in the way people view the 10- or 20-year growth rate can have an important effect on overall stock market valuations, but GDP growth may not be affected in the short-term."

A downturn limited to the stock market might also happen ifanalysts were to change their ideas about whether certain kinds ofcompanies are profiting from trends, he suggests.

Either way, when skepticism remains limited to a few areas of themarket, recession can often be avoided. That's the conclusion that can be drawn from a survey of post-War financial history: In cases where market declines occurred without recessions, the market downturns tended to be narrowly focused.