Ahead of the Curve book jacket
Home 3 Simple Rules Charts Data Contact Buy the Book
<< Previous | Next >>
Figure 4-1: Economic growth, recessions, and the stock market: A REMARKABLE CONSISTENCY
Figure 4-1
Perhaps the single most important insight in getting “Ahead of the Curve” in forecasting economic cycles is that of recognizing the lagging characteristic, even deceptiveness, of “recession” as a measure of economic downturn. Businesses suffer loss of sales, inventory buildup, and slowing-to-declining corporate-profit comparison when the rate of growth in economic activity (real GDP, measured here on a Y/Y percent-change basis to provide clarity) peaks and begins to slow. By the time real-GDP growth is approaching “zero” growth or an actual decline (“recession”), most of the economic damage has been done, it is far too late for businesses to adjust, and the bear market is largely over.

Note that bear markets (shown here in the vertical yellow shaded bars) almost always begin when the rate of growth in real GDP is at or still close to its peak (see red arrows), and continue as the rate of growth continues to slow.* Recessions are denoted here by the black boxes at the bottom of the chart. Note how belated they are as a measure of economic harm. Businesses and investors must instead focus on leading indicators of rates of economic growth, particularly drivers of consumer spending, which represent the front end of the economic cycle.
Current Comment:
Completely consistent with past cycles, the extreme 2007-2008 bear market ended (see blue arrows) when the Y/Y rate of growth in real GDP was still approaching a bottom in early 2009. As always, wise investors needed to summon the courage to buy when the outlook was at its worst; this chart was helpful in supplying the necessary courage to do so.

Y/Y real-GDP growth reached its peak for the current cycle at the end of 2010 (see red arrow), has been at a 1-2% run rate in 2011-2012. The stock market is likely to remain in its recent (relatively volatile) trading range as long as Y/Y real-GDP growth holds at current levels, but any slowing in real-GDP growth (highly dependent on consumer spending) from here would likely trigger a bear market.

*The 1976-1980 period is an anomaly to this pattern and is discussed in Ahead of the Curve
Source: Real gross domestic product: Bureau of Economic Analysis
Updated: 4/6/14