Debunking a Few Stock Price Myths

Are we in a recession? If we are not we will be very soon, according to the latest reports on the health of the economy. As it begins to look more and more as if a recession is inevitable, I thought it would be worthwhile to take a look at the last four U.S. recessions and see how stock prices behaved. But first, a little background on all of the gloom and doom.

The Bad News

Housing prices, the largest single asset for most Americans, fell 11.445 in January according to the Case Schiller Index. This is the steepest decline since they started tracking housing prices in January of 1987, 21 years ago.

Factory activity is down, as is the Conference Board's Index of Leading Economic Indicators. The only thing up is short-term bond prices and unemployment claims.

The consumer confidence index fell to a 15-year low, and their expectations going forward are the lowest since the Watergate crisis and oil embargo. It is a perfect storm for the U.S. economy, and I can find no signs of near-term improvement. We got so used to using our homes as a giant ATM machine to fuel our overspending that the drop in housing prices has left us stunned.

A recession is officially defined as two quarters of negative GDP growth. We have not had that yet, but I suspect the first quarter of 2008 will be the quarter that sets up the recession.

Two Untruths

As to stocks prices, there are all kinds of myths about stock prices in a recession, so I wanted to see how prices did, in fact, react. What I found surprised me and challenged more than one Wall Street adage.

The first misperception I discovered was that stock prices fell before a recession. In fact, this was not really true. In the three months prior to the last four recessions, three out of four times, stock prices were rising. Only in the last recession, from March to November of 2001, did stock prices fall prior to the recession. All the others, January to July of 1980, July 1981 to November 1982 and July 1990 to March 1991, had stock prices moving higher leading up to the start of the decline in economic activity.

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At the time of publication, Melvin had no positions in the stocks mentioned, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.