Recessions, Predictions and the Stock Market

Only Sell Stocks in Recessions?

We were recently made aware of an interview at Bloomberg, in which Tony Dwyer of Cannacord and Brian Wieser of Pivotal Research were quizzed on the recently announced utterly bizarre AT&T – Time Warner merger. We were actually quite surprised that AT&T wanted to buy the giant media turkey. Prior to the offer, TWX still traded 50% below the high it had reached 17 years ago.

The merger as such is actually not what we want to discuss though. Rather, it is a remark of Mr. Dwyer’s regarding the stock market in general and what the recent merger mania is signaling. He makes two major points in the course of the conversation. For one thing, he notes that the merger (along with many other mergers that have recently been announced) is the result of the extremely easy availability of credit.

TWX Time Warner and AT&T

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The merger of AT&T and TWX simply doesn’t appear to make much sense. It certainly is a symptom of loose monetary policy though.

You can watch a video of the interview here:

Tony Dwyer and Brian Wieser opine on the T-TWX merger – Dwyer’s remark on when to sell or not sell stocks is of particular interest to us (in case the video doesn’t play, here is a link)

The Problem with Predictions

The problem with this is of course that by the time everybody realizes that  a recession is actually unfolding,  the stock market is usually already half-way to making its bear market lows. Mainstream economists and central planning bureaucrats are usually particularly clueless when it comes to forecasting recessions. They don’t even recognize them when they are staring them into the face.

As an example, shortly before the market crashed in 2008, nearly everybody denied that a recession might already be in train or might be imminent. The ECB actually hiked its main refinancing rate in the summer of 2008. It is fair to say that no-one at the ECB had even the foggiest idea that an economic contraction was already underway.

Later NBER backdated the beginning of the recession to November of 2007. So the argument that one should not sell in the absence of a recession is really not sensible, since it is predicated on the notion that  1. people will actually be able to recognize that there is a recession and 2. will then act on this recognition in a timely manner in the stock market.

European Central Bank, Benchmark Rate

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The ECB hiked its main refinancing rate in the summer of 2008. By this time, the recession was approximately 8 months old.

It is of course true that stock market declines very often go hand in hand with recessions. Historically the stock market often tends to lead the economy in economic downturns, but not always. The lead times are quite variable and sometimes very painful market declines can occur without a recession (such as e.g. in 1987).

In order to successfully estimate likely long term market returns one doesn’t really need to forecast the timing of recessions anyway – one mainly needs to consider valuations (price/ earnings, price/sales, Q ratio, etc.).

In the short to medium term the market can obviously deviate considerably from what valuations suggest about its long term outlook, and traders focused on shorter time frames are usually better served by employing technical analysis, or even better, a mixture of fundamental and technical analysis.

Lastly, investors cannot possibly escape the losses generated by a market decline collectively. Consider someone who is timing the market perfectly and is selling right at the top. Someone else has to buy the shares he is selling, so the buyer will then make the losses the seller manages to avoid. This continues down the line with every transaction made while the bear market lasts.

Wilshire 5000 Total Market Full Cap Index

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In the last recession the stock market’s lead time was very short – but the recession was only officially recognized after it had been underway for almost a year already.