Markets Vs Economy

There is much talk in the media and blogs of late about the current slowing in economic growth. There is little doubt that growth has slowed. The only question is by how much. Some are claiming that the government's numbers greatly overstate the economic activity and that we are already in another recession, while others only seem to think that another recession is imminent.

The problem with much of this talk is the implicit conclusion that the stock market must necessarily fall further, and possibly significantly, if we are in or headed into another recession. This is an erroneous conclusion, but it is being used to justify extreme predictions of stock market collapse in the year ahead. This is not to say that such a collapse can't or won't occur, but basing it on economic reports is not a valid approach to market forecasting.

In 1990, the SP500 fell around 20% and the decline ended in October 1990. The 1990-1991 recession officially ended in March of 1991, 5 months later. Presently, the SP500 has fallen 17.1% from its April peak, and if it bottoms this fall around 950 as I suspect, the total decline will be around 22%, which is about the same as that of 1990.

Please don't misunderstand what I am saying here. I am not trying to say that we are looking forward to a stock market advance like the 1990s. Certainly we are not. What I am saying is that the present slowing in economic activity has already been discounted by the stock market. Any additional stock market decline into the fall will probably mean that economic growth will continue to slow into early 2011 before a renewed resurgence in the latter half of 2011 and into 2012.

When technical market analysts of whatever school start using economic reports to support their analyses and forecasts, their work is suspect. If we have learned anything from the last 100 years from market analysis, it is that the market is a leading indicator. Therefore, any economic forecast that is not at least six months to a year ahead of market forecasts is of little value to market participants.

Furthermore, do not discount local anecdotal evidence in your understanding of the state of the economy. As bad as things are in many areas, there has been an increase in economic activity over the last year. In fact, a colleague of mine, a civil engineer who does land and development planning, presently has the most work he has had in over three years. He may have to hire more help to stay on top of all of the work. Land and development planning is the first step in both residential and commercial new construction work.

In conclusion, I am still expecting a fall selloff and we will probably see additional slowing of economic activity over the next six months, but it will most likely be followed by a resumption of the stock market uptrend and greater economic activity in 2011 and 2012. At that point, it will be time to be prepared for a more significant decline in both the stock market and the economy.