The Wall Street Waltz: 90 Visual Perspectives, Illustrated Lessons From Financial Cycles and Trends, Revised and Updated Edition

Chart 25

Stock Prices versus Recessions

Oh, my God! Everyone says we're in a recession, so I'd better sell my stocks fast. Right? Probably not. It turns out that you can do a pretty good job of predicting the economy using prior changes in stock prices, but predicting stock prices from economic forecasts works almost not at all.

Here's why: The stock market is almost magical because it always leads the economy. It goes down long before the economy drops and then heads higher long before the economy rebounds. It always has.

This classic chart plots the S&P 500 from 1948 to 1976, but does so on a background that is shaded during periods of economic recession. The white areas are times when the economy was expanding. The beginning of a shaded area represents when the expansion first turned into a recession. The end of a shaded area denotes when the recession ended and the next business expansion resumed. For example, note 1970. The shading tells you that the economy started declining just before the year began and dropped without interruption until year-end. It also lets you see that the economy then expanded throughout 1971, 1972, and most of 1973.

Now note the relationship between the shaded, recessionary years and the stock market. Stocks drop for many months before the economy sours—often for a year or more. And stock prices always head higher long before the worst depths of a recession's decline. For example, consider that 1970 recession. Stock prices peaked out in 1968, more ...