Stocks Marching to Dismal Scientists' Beat

For once, Wall Street's economists have managed to sing in harmony. Recovery, they say, will have begun by the end of the first quarter next year. This, understandably, is music to the market's ears: Stocks have always bottomed ahead of the economy.

But that doesn't mean investors have to dance along.

From the beginning of the year right on up to Sept. 11, there was a lot of bickering among the dismal scientist set. Some saw recession in the offing; others said the economy would skirt it. Early on, many forecasters thought the economy's eventual recovery (whether from a mere slowdown or a recession) would be V-shaped; others opted for a less-fun U. And so on.

With the terrorist attacks and the resulting deep confidence shock, however, economists agree that the U.S. has entered recession. There is also a consensus that the economy will bottom soon.

An informal poll of 10 major Wall Street firms found economists remarkably uniform on when the trough will take place: All thought it would come in the current quarter or in the first quarter of next year. The downturn may not be over yet, they said, but soon the Fed's aggressive rate cuts, the government's latest fiscal plan, the 25% drop in pump prices since April and the extent to which both companies and households have eliminated excess will send the economy on the road to Wellville. (See table below.)

Bottoms Up!
Firm	Economic Trough Prediction
Banc of America Securities	'Just around year end'
Bear Stearns	First quarter
Credit Suisse First Boston	Fourth quarter
Deutsche Bank Securities	'Around February or March'
Goldman Sachs	'Sometime in the winter'
J.P. Morgan Chase	First quarter
Lehman Brothers	'Probably around February or March'
Merrill Lynch	'At the end of this year or the beginning of next'
Morgan Stanley	'Around the end of the year'
Salomon Smith Barney	'Late this year, early next year'
Source: Companies

Within this context, the rally in stocks since Sept. 21 and the fast-growing belief that the market has in fact touched bottom make sense.

In the past 50 years, there have been eight recessions; inevitably, the market hit its nadir before the economy did. The average lead time between the S&P 500's low and the economy's trough was five months. (The longest lead time was eight months, in 1953; the shortest, three months, in 1982.) Tack five months on to Sept. 21 and you're at the tail end of February. The bottom in stocks came right on schedule. It's uncanny, isn't it?

Looking Past the Shadow of the Valley
S&P 500 Trough	Economic Trough	Difference
September 1953	May 1954	8 months
October 1957	April 1958	6 months
October 1960	February 1961	4 months
May 1970	November 1970	6 months
October 1974	March 1975	5 months
March 1980	July 1980	4 months
August 1982	November 1982	3 months
October 1990	March 1991	5 months
Median		5 months
Source: National Bureau of Economic Research

Enter the Bears

You probably figured out that this was where the bear case would come in.

The problem with economists' predictions is that they aren't very accurate -- particularly during times of recession. According to a quarterly survey conducted by the Philadelphia Fed in May 1990, forecasters expected gross national product to grow by an annualized 2.5% in the third quarter of 1990. In fact, it fell by 0.7%. That August they thought that fourth-quarter GNP would grow by 0.8%; it fell by 3.3%. In November 1990, they decided that GNP would fall by 0.9% in the first quarter. It dropped 2%.

The forecast history from the 1981-82 recession followed a similar pattern, notes Lehman Brothers economist Ethan Harris. "There is a sun-will-come-out-tomorrow kind of feeling," he says. "The consensus forecast always expects the recovery within a quarter throughout the whole recession."

Yep, Harris expects the economy to recover "around February or March." He does say, however, that the risk to his forecast is that the recovery comes later.

The Sun Will Come Out... Median GNP growth predictions vs. actual data

Source: Philadelphia Fed.

"In fairness to the economics fraternity," says J.P. Morgan equity strategist Doug Cliggott, "the one thing that's almost impossible to do is call turning points."

Even though he's impressed that economists so unanimously see the trough coming soon, Cliggott has a hard time imagining the economy turning around early next year (even if the economists at his firm do not). "It isn't unthinkable that the bottom is in January or February, but I'm skeptical," he says. "What's going to get the growth going? That's only three or four months away."

If he's wrong, however, Cliggott says that the market probably has bottomed and that his belief that there's worse to come will be a mistake. And that he will be sorry to have spent the time when everyone else was fox-trotting standing by the wall, staring at his shoes.