Monday, September 26, 2011

Do Stock Market Declines Predict Recessions?

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.


yvesT said...

Would also be interesting to see if the green dots were followed by "almost recession" or not

mbpioneer said...

I thought the guy the other day was getting a bit picky about your color choices representing multiple data sets being tough to decipher with his color blindness. But this red/green choice is just impossible to see for those of us with the most basic form of color blindness.

Try blue instead of green, and keep up the good work.

The Arthurian said...

Ha... My first reaction to the graph was "Wow that's pretty."

There was a near-recession in 1966-67.