FYI | Mar 27 2008
By Greg Peel
Deloitte might be an accountancy firm, but it is happy to weigh in with some interesting historical statistics surrounding past US recessions and what usually happens next.
Consider first that since the beginning of 2008, the S&P 500 index (large cap stocks) is down 11%, the Russell 2000 index (small cap stocks) is down 12.5%, the MSCI Europe, Australasia and Far East index has fallen 9%, and the MSCI Emerging Markets index has fallen 13%. These are significant falls.
Consider now that the cumulative returns for the period 2003-07 have been 83% for the S&P 500, 112% for the Russell 2000, 166% for the MSCI EAFE, and 383% for the MSCI EMI.
If one assumes a recession actually began in the US in December, it is useful to look at how the recessions of the past 50 years played out. If this recession were to play to the average, it would last until October. The S&P 500 would ultimately fall 24.38% before turning around. Within one year it would have rallied 31.44% Within two years it would have rallied 56%. The turnaround in the index would occur somewhere between 4-10 months before the bottom of the business cycle which, in this case, means any time between now and July.
The S&P had fallen 20.2% from its 2007 high to its recent low. If that proves to be the extent of the correction, the index will have to rally 25.5% to retest the high. However, the longest recession in the last 50 years, following the Arab oil embargo of 1973, lasted 16 months and caused the S&P to fall 46%. But it still performed relatively well on the way out, as the following table suggests:
Deloitte is also happy to point out several factors in place today which should help to keep any recession shallower than most. Firstly, balance sheets of non-financial companies were strong going in. Secondly, there was not a lot of hiring on the way up, meaning there should thus be little firing on the way down. Thirdly, inventory levels have been low on the way up. Typically recessions impound when companies have overextended their balance sheets, over-hired staff and built up inventories.
But perhaps most importantly, growth in much of the rest of the world is still strong, which also provides a market for US exports.
Given this current crisis is in the banking sector, Deloitte recommends looking at two specific factors as signals for a bottom. Firstly, a feature of the crisis has been the freezing of the asset-backed commercial paper market, which had shrunk for 18 weeks in a row from August. It has recently shown signs of stabilising, and any growth can be taken as a sign of turnaround. The second is the Fed’s Term Auction facility – the means by which commercial banks access funds. The Fed has been furiously pumping liquidity into the system via this facility, and has since extended it temporarily by other means to investment banks. When this facility is no longer being utilised, it could be all over.
As to when that might happen is as yet unknown.
But Deloitte does advise that investors with a time horizon greater than one year would be foolish at this point to be unwinding stock positions and hiding in cash. As most recession bear markets have recovered within the space of one year, longer term investors are at risk of missing the early returns. To quote Baron von Rothschild, “The time to buy is when there is blood in the streets, even if it’s your own”.
The accountants also remind, however, of what it always says in the fine print:
“Past performance is no guarantee of future results”.
