Trouble in the markets. The end is nigh. Or at least the beginning of the end is nigh. Thanks to China’s slowdown and the descending price of oil, stock markets have had a terrible start to the year – and many are predicting worse to come. The fear is that these financial disturbances are an augury of the economic despair that will follow, for the rest of us, later in the year. All these traders and investors know what’s up better than anyone else, don’t they? So something bad must be coming, mustn’t it?
Share indices pre-empt recessions… There is no certainty in the future, but we can gaze backwards into the past. The above graph shows the S&P 500 share index, adjusted for inflation, since 1926, with periods of recession shaded in grey. There are times when the index hasn’t pre-empted a downturn: for instance, it continued rising into the start of the Great Depression in 1929, only declining a few months later. But, looking at the entire timeline, it has tended to wilt ahead of the economy wilting: it shrank, for instance, by about 24 per cent in the year before the recession of 1973-75.
…and not-recessions. The trouble is, the S&P index has wilted even when the economy hasn’t. Scan along the graph, and you’ll see numerous crashes outside of periods of recession. One happened in 1987, when a 31 per cent decline happened across just four months. The next recession was unrelated and came three years later.
The British experience. I’ve used the American S&P 500 index for this post, along with American recessions, because it goes back further than the main British share indices. However, I’ve produced a graph for our own FTSE All-Share index, since 1975, to the right, which you can click for a larger version. It tells a similar story. Share prices have declined ahead of Britain’s recent recessions, including by 9 per cent in the year to the Great Recession, but they’ve also declined outside of them. There was a 40 per cent fall around 2001-03, unaccompanied by any economic downturn.
An imperfect barometer. All of which is to say, the stock markets are some sort of barometer for the wider economy, although an imperfect one. They generally fall ahead of the economy falling. They occasionally rise ahead of the economy falling. And they often fall even when the economy is rising. This, by itself, doesn’t yield many conclusions for the here and now, but that’s high finance for you: messy, uncertain and easier to handle in retrospect.