Download The Ups Win

Vol. 36 No. 2
March 23, 2009
The Ups Win
by Bill Dickneider
D
o the stock market and
the economy have any
thing in common with
practicing a sport like basketball?
In a way, they do. During some
practice sessions, you can be at
peak performance; it seems like
you can’t do anything wrong. At
other times, the ball refuses to go
through the hoop; it seems like
you can’t do anything right.
Despite these ups and downs,
however, you continue to practice,
and your skills gradually improve.
Our economy and the stock market
also have their ups and downs.
After peaking at 14164 in October
of 2007, the Dow Jones Industrial
Average (Dow) fell to 6547 by early
March of 2009 — a decline of more
than 50 percent. The latest report
from the Department of Commerce
showed that the economy’s total
production (inflation-adjusted
gross domestic product, or real
GDP) fell by an annual rate of 6.2
percent in the fourth quarter (last
three months) of 2008.
A business cycle is a pattern of
repeated fluctuations over time,
in which the economy expands,
peaks, contracts, and then
reaches a trough or bottom from
which a new expansion begins.
Cycles
t’s easy for investors to become
discouraged during times like
these, just as discouragement can
accompany practice sessions that
don’t go well. But ups and downs are
nothing new to the economy and the
stock market. They’ve survived
many of these fluctuations —
otherwise known as business cycles.
I
The chart below shows business
cycles in our economy from 1950
through 2008. During these years,
the economy survived 10 periods
when contractions in production,
Sources: Economic Data - Federal Reserve Bank of St. Louis, FRED® Data Base, http://research.stlouisfed.org/fred2/;
National Bureau of Economic Research, http://wwwdev.nber.org/cycles/cyclesmain.html.
employment, and incomes were severe enough to
be called recessions.1
change in step with the economy as it moves through
the various stages of the business cycle.
The current recession began in December of 2007
and has lasted 15 months so far. The average
length of the 9 previous recessions was about 10
months, with those of 1973 to 1975 and 1981 to
1982 lasting 16 months.
The recession of 1973-75 (Chart 1, #5), began in
the fourth quarter of 1973, after the economy
peaked and began contracting. The downturn
lasted until the economy reached a trough in the
first quarter of 1975. At that point, total production (real GDP) had fallen 2.2 percent during the
recession. Similarly, the Dow Jones Industrial
Average had declined 34.9 percent.2
No two business cycles are exactly alike. Their
length, severity, and cause can differ — as well as
their effects on employment, production, and stock
prices. What’s more, the duration and strength of
any given contraction or expansion doesn’t
indicate the timing or strength of the next
expansion or contraction.
The scale shows proportional changes in the Dow, Source: Dow Jones
Indexes, http://www.djaverages.com/?view=industrial&page=index-data.
Chart 1 on the first page shows that despite the ups
and downs of the business cycle, the total production of
goods and services still grew by about $10 trillion
between 1950 and 2008. Similarly, the stock market
also rose over the same period, as Chart 3 above
illustrates. Even though the Dow declined due to
recessions and other events, it still rose from 206 in
1950 to 8776 by the end of 2008. Over the years, the
ups have clearly beaten the downs in the stock market
and general economy.
1 The National Bureau of Economic Research defines a recession
as “a significant decline in economic activity spread across the
economy, lasting more than a few months, normally visible in
production, employment, real income, and other indicators. A
recession begins when the economy reaches a peak of activity and
ends when the economy reaches its trough. Between trough and
peak, the economy is in an expansion.” http://www.nber.org/
cycles.html.
Sources: http://data.bls.gov/cgi-bin/surveymost?ce; Federal
Reserve Bank of St. Louis, http://research.stlouisfed.org/fred2/
categories/18; Yahoo!Finance, http://finance.yahoo.com/q/
hp?s=^DJI
Chart 2 above illustrates some of the effects of the
current recession. Stock prices began falling in
2007, before employment and real GDP turned
down in 2008. This behavior of stock prices isn’t
surprising, however, because stock prices are
“forward looking,” which means they reflect
investors’ anticipations of the future. If investors
correctly expect a recession in the near future,
stock prices may fall even before the downturn
begins. In contrast, payroll employment tends to
2. The stock market is generally forward looking, so stock prices are
likely to turn up before the economy reaches a
trough and the recession ends.
Accordingly, the Dow’s changes
on the chart show the
percentage change from the
prior peak to the quarter just
before the recession’s end.
To Think About
✔ Do you think the
stock market’s ups will
continue to win in the
future? Why or why not?
✔ Use the web site in
footnote #1 to compare
the duration of the
expansions beginning in
1981 and 2001.