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A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.

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Stock Prices and Recessions


"The U.S. economic reports continue to impress," says Scott Anderson, Chief Economist at Bank of the West, who notes that the data "reveal a resilient private sector economy that accelerated over the first two months of the year, despite the headwinds from higher payroll and personal income taxes." Not even higher gas prices seemed to get in the way of consumers, who are choosing to dip into their savings to sustain their current pace of spending.

The consensus among analysts, economists and investors is that maybe the U.S. economy is a bit stronger than expected, which may allow it to absorb the sequester. While the effects of the across the board spending cuts will likely impact Q2, for this moment in time, the world wants to party like it's the 1990's all over again. In fact, it was November 1996 when the Dow Jones Industrial Average last logged 10 consecutive winning sessions in a row. The current streak was broken on Friday, though the bulls appear to be firmly in control.

But Lakshman Achuthan, co-founder of Economic Cycle Research Institute (ECRI), is not convinced. In September 2011, ECRI made a recession call, which it then clarified in December 2011. Based on the business cycle research that ECRI conducts, the firm projected that a mild recession would begin by mid-2012, but would not be recognized before the end of 2012.

Achuthan, with whom I have appeared numerous times on CBS and CNN, recently explained the call to me, citing a Fed study from two years ago (read the full ECRI report here). According to Achuthan, based on the Fed's variables, there is no doubt that the U.S. economy had reached "stall speed." He noted that many recessions are only seen in retrospect, after official revisions have occurred. The fact that the economy is likely in a recession means that the Fed's pledge to provide unlimited and ongoing monetary stimulus via monthly bond buying "makes more sense."

What about all of that improving economic data? Achuthan says we should be wary of downward revisions to the rosier than expected reports and that some of the numbers are skewed due to seasonal adjustments. He also notes that there were temporary distortions due to Superstorm Sandy and precautionary actions to the "fiscal cliff."

"But of course, there is the elephant in the room, the impressive upturn in stock prices. How can we possibly be in a recession if the stock market is doing so well?" asks Achuthan. It is important to remember that the stock market is not the economy and the economy is not the stock market.
{Stock prices can rise during recession, please see page twelve.}

The Economist recently noted, "It is tempting to attribute the strength of the Dow to optimism about the American economy. Tempting, but wrong. Studies have shown almost no correlation between GDP growth and equity returns...this rally in the Dow has been accompanied by the weakest GDP growth of all the bull markets since the Second World War."

Achuthan wants people to know that "cycles in economic growth and stock prices do not always move together. It is true that 80 percent of the past 15 recessions has associated equity bear markets, but in three of those 15 recessions there not cyclical downturns in stock prices. Specifically, this happened in 1980, 1945 and 1926-1927."

Regardless of whether the U.S. economy is in a recession or not, the conversation with Achuthan underscored that the recent euphoria in the stock market should be taken with a healthy dose of cynicism. As Warren Buffett likes to remind us, we should "be fearful when others are greedy and greedy when others are fearful."

VIEW THIS ARTICLE ON CBS

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