I think it was the economist Ezra Solomon who, some years ago, first said that the purpose of economic forecasting is to make astrology look good. In his most recent column at the Washington Post, Robert Samuelson compares the apparently diverging views of economists and stock traders on the state of the economy:
It’s economists vs. the stock market. Economists generally don’t forecast a recession anytime soon. The stock market does — or at least that’s one plausible interpretation of its recent roller-coaster behavior. Who’s right? We’ll know in a few months. Meanwhile, the dispute highlights the incomplete nature of the present recovery, which has lasted a long time but, to millions of Americans, still feels unsatisfactory.
Economists have long disparaged the stock market’s predictive powers. They like to quote the late Paul Samuelson (no relation to this writer), a Nobel Prize winner, who once said that the stock market had forecast nine of the last five recessions — a biting verdict on the market’s clairvoyance. It’s true that modest stock “corrections,†declines of 5 percent or 10 percent, haven’t foretold recessions. But that’s not true of bear markets, conventionally defined as declines of 20 percent or more.
Writing in Real Clear Markets, Brookings Institution economist George Perry notes that, by this standard, there have been seven bear markets in the past 50 years, and five of them have been associated with recessions. The recessions began in 1969, 1973, 1981, 2001 and 2007. Bear markets in 1966 and 1987 were not followed by recessions. Also, recessions in 1980 and 1990 were not predicted by bear markets.
He goes on to look at what the stock market’s been doing:
By the Standard & Poor’s index of 500 stocks, the market’s recent peak occurred May 21 at 2,130.82. At the market’s close Friday, the index had dropped to 1,864.78, a decline of about 12 percent. This suggests that, though the economy may slow (it already has), it won’t succumb to recession. That’s usually defined as two consecutive quarters of economic contraction. However, another index is closer to the historic danger zone. The Wilshire 5000 index covers more stocks. Since its peak on June 23, it has fallen by 15 percent, representing a paper loss of $4 trillion, says Wilshire.
I note that he doesn’t look at the DJIA:
I’m no market analyst but as I read that peak was at 18,448 and the close yesterday was 16,443 or a roughly 12% decline. Just as important is the trend and that’s down.
The one thing I’m missing from Mr. Samuelson’s analysis is that, although he does provide a little analysis of how well the bear markets have predicted recession, he doesn’t give us any clues as to how well economists have done. I’ll provide that. The record of the consensus of economists is practically unblemished in failing to predict recessions. In other words no matter how you stack it, bear markets have done a better job of predicting recessions than economists have.
This looks like a good place for me to reassert something I’ve claimed for decades. There’s a good reason for the failure. Economics isn’t a predictive science but a descriptive one like anthropology or psychology.
What does all of this mean for the U. S. economy? Beats the heck out of me. As I’ve said before I think the global economy will experience a pretty severe contraction and, while there will be a contraction here, it won’t be nearly as severe.
The one thing I’m missing from Mr. Samuelson’s analysis is that, although he does provide a little analysis of how well the bear markets have predicted recession, he doesn’t give us any clues as to how well economists have done.
I noticed that flaw in the article too. The article would be like reading a criticism of the Carolina Panthers, and their failure to beat the Denver Broncos, from the perspective of the Cleveland Browns.
The only way to forecast recessions with precision is to stick electrodes in the brain of every American to read their state-of-mind in real time. It’s always about confidence.
I’m not sure why anyone would expect equities markets to necessarily predict recessions. At the most fundamental level equities prices are the product of earnings and valuations. Valuations can get relatively high but correct (and they always do) without necessarily signaling recession.
Earnings declines are more likely to reflect general economic activity, but still not necessarily be of a magnitude to signal recession vs a simple slowdown.
I’d suggest that inventory positions, orders, personal spending capacity (wages and debt and taxes), technological events, potential investment returns, regulatory burden, global events and yes, confidence, are more the witches brew that make for recessions. Equity prices are more reflective than causative, and impossibly out of phase with economics to be other than mildly predictive.