Markets Usually Move First

Source: FactSet, 6/30/2019.

Stocks reached new highs in early July despite signs of a slowing economy, making some investors worry that we could be near the end of this cycle. Since the most severe stock market declines have coincided with recessions, we constantly evaluate many leading indicators, but we don’t think either a bear market or a recession is likely near-term. Most of indicators remain positive, and the Federal Reserve has shifted its policies to help sustain economic growth. As a result, we expect this long-running expansion to continue, fueling the bull market and rising stock prices over time.

Where stocks lead, the economy may follow – Market and economic cycles are linked but aren’t identical. The stock market usually moves first but isn’t a particularly reliable guide to the economic outlook. As the chart shows, stocks have peaked and then dropped by 20% or more (a bear market) before past recessions have begun. The start of a bear market has led recessions by seven months on average – but the lead time ranges from three to 13 months. The chart also shows stocks lead the recovery, rebounding an average of three months before the recession ends. Stocks are volatile and have dropped when no recession followed, and the stock market hasn’t anticipated every recession. Since stocks react to emotions, valuations and other fundamental data, they’re a very noisy signal about economic health.

Bull markets are longer, stronger than bear markets – Bull markets have lasted 54 months on average; bear markets last about 15 months. This is important for investors because it means stocks rise more often than they decline, and the increases tend to be bigger. Similarly, the economy tends to continue to grow unless shocked into recession due to a bubble that bursts or overly high interest rates. As a result, economic expansions have lasted an average of 60 months, while recessions also have been comparatively short, lasting 11 months on average.

Action for Investors

Long-term investors realize that staying invested over time, even during painful pullbacks and bear markets, is likely to be a better approach than trying to time the market. Keep time on your side by using short-term pullbacks as opportunities and staying invested in an appropriate mix of stocks and bonds based on your risk tolerance, time horizon and goals.

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