Wall Street sell-off prompts talk of recession But stock market is not an infallible crystal ball

September 06, 1998|By William Patalon III | William Patalon III,SUN STAFF

Investors who try to use big stock market drops to predict economic problems could get themselves caught in one of the oldest bear traps around: that bear markets predict -- or even cause -- recessions.

"You know the old joke: The stock market has predicted nine of the last five recessions," said Mark Zandi, chief economist for Regional Financial Associates in West Chester, Pa. "It's not an infallible indicator."

Economists have been reluctant to christen the 18 percent fall the Dow Jones industrial average has seen since July 17 as the first real bear market the country has seen since the one that ran from December 1980 to July 1982.

And most do not believe the nation's economy is headed for a recession, though some of the big money-center banks and other economists say growth could slow to as low as 1 percent next year.

"We're looking for growth in the second half [of this year] of 2 to 2.5 percent and next year 1.5 [percent] to 2 percent," said Ira Silver, chief economist for J. C. Penney Co. Inc. in Plano, Texas. "That's a significant slowdown" but not a recession.

The questions on the minds of investors and economists alike right now are these: Are we in a bear market? And, if so, does that bear market mean the U.S. economy is headed for its first recession since 1990-1991?

Evaluating bear markets and recessions can be a tricky business.

Both demand the benefit of hindsight: You can't really call a bear market or a recession until you've been in one. And the definitions are a lot like tax codes of old -- if you look hard, you

can find lots of loopholes.

Take a bear market. The technical definition is a drop in stock prices of at least 20 percent.

What gauge to use?

But what index? Most look at the Dow Jones industrial average, the group of 30 stocks that the investment community uses as the barometer of the overall stock market's health.

But the Standard & Poor's 500 is a much broader index and is the index that's one of the components of the Composite Index of Leading Economic Indicators that many economists say is the best-available forecasting tool.

Both the Dow and S&P 500 are down about 18 percent since peaking in July, short of the 20 percent threshold and too short in duration to be a bear market, some say.

"I'm not ready to call this a bear market," said Robert T. Sweet, chief economist for Allied Investment Advisors in Baltimore.

But others counter by saying that the stocks of small companies -- known as "small caps" -- have been in a bear market for months. The Russell 2000 index, one generally accepted measure of small stocks' health, is down 29 percent since peaking in late April.

With bear markets, there's also a question of duration and fear. Ibbotson Associates, the Chicago-based research house known for its stock-market insights, labels as a bear market the Oct. 19, 1987, Dow nose-dive of 508 points that over two months helped shave 29.5 percent off the S&P 500. However, economists such as Sweet do not agree. They see the 1987 crash as a correction that was but a temporary breather in a bull-market run that began in August 1982.

The same is true of the Oct. 27, 1997, plunge of 554 points, which in percentage terms was a decline of only 7.2 percent. After that breather, the Dow would climb nearly 2,200 points -- or 23 percent -- to its mid-July peak.

"I think [the stock market] is a useful indicator, but it's not always right," said David Orr, chief capital markets economist for First Union Corp. in Charlotte, N.C. "You don't tend to have recessions without some disturbance in the stock market. But you do sometimes have stock-market disturbances without economic trouble."

Calling a recession is a bit easier than calling a bear market. Technically, a recession is defined by economists as a downturn in economic activity, represented by two consecutive quarters or more of decline in a country's gross domestic product (GDP).

According to government figures, using that strict definition, there have been eight recessions since World War II. Two were preceded by stock-market downturns that technically classified as bear markets: A 29.3 percent drop in the S&P 500 from December 1968 to June 1970 that came before the 1969-1970 recession, and a 42.6 percent decline from January 1973 to September 1974 that preceded the 1974-1975 recession.

Pre-downturn corrections

Interestingly, there were several corrections exceeding 14 percent that began before economic downturns:

A 15 percent drop from March to December 1957 that came in front of the 1957-1958 recession.

A 15.9 percent fall from December 1980 to July 1982 that preceded and coincided with the 1981-1982 recession.

And a 14.7 percent decline from June 1990 to October 1990 that started before the relatively mild 1990-1991 recession.

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.