Thursday, December 11, 2008

Economy and Markets Often Go Separate Ways

By Andrew M. Gordon

It's official. We're in a recession. So it's a good time to explore how the stock market does when the gross domestic product (GDP) goes down.

Since we've had negative S&P 500 growth in every quarter of our current recession - which began a year ago this month - it may seem that a falling economy is always accompanied by a falling stock market. But this is not true.

The most recent examples of this not happening are the fourth quarter of 1990 and the first quarter of 1991. GDP dropped 3 percent and 2 percent respectively, but the S&P grew.

In the post-WWII period, there have been 36 quarters when the GDP has shrunk. During those periods, the S&P actually gained 1.03 percent.

One reason for this is that the markets tend to rebound 3-5 months before a recession ends. That very last quarter of a recession usually shows significant market growth. And the next-to-last quarter also often shows positive growth.

This recession will continue well into next year (at the very least). But that, by itself, doesn't automatically mean the markets will continue to contract.

If there are signs of economic recovery in housing or retail or auto markets, for example, the S&P could very well rally. Unfortunately, I expect the economic news to continue to be bad. And as long as it is, it'll be hard, if not impossible, for the markets to turn back up.

There's no need to rush back into the market at this point, especially when you can get 6-8 percent interest on investment-grade bonds at very little risk. If you like tax-advantaged bonds, municipal bonds are also offering attractive interest rates.

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