Monday, September 26, 2011
Does the recent stock market decline tell us anything about the odds of a coming recession?
Well, if history is any guide, the stock market does sometimes successfully predict a recession ahead of time (see the red circles in the above log-scale graph of the S&P 500 since 1960). However, there's at least as many episodes of similarly large declines that did not segue into a recession (green circles). So, knowing nothing else, you'd say the recent stock market decline has roughly a 50% chance of ending in a recession (and if it does, it will go down a lot more).
Interesting to note that there's at least a couple of recessions (1980 and 1991) where the stock market did not see it coming.