Timing the Economic Recovery – When is it Going to Happen?

The short answer is that it is impossible to accurately predict when the economic recovery is going to come.

Share markets typically bottom about six months before the economic cycle. Thus, if economic growth is going to bottom and start turning higher from later this year then it would be consistent with shares having bottomed during the first half of this year. Alternatively, if the recovery is going to be another 12 months or so away then the risk of a new low in shares is much greater. Economic data relating to current or recent past economic conditions remain poor. US retail sales data indicates that US consumers are still cutting back, gross domestic product (GDP) has fallen at an alarming rate and unemployment is still rising everywhere.

However there are a range of considerations that provide some confidence that an upturn in the economic cycle is moving into sight for later this year.

Governments worldwide have provided massive stimulus in the form of fiscal and monetary policy, and assistance for banks. They have also resisted the temptation to put up trade barriers. This is the opposite of what happened in the 1930’s, making comparisons to the Great Depression increasingly meaningless.

There is increased evidence that recent stimulus has gained traction in financial markets. Interbank lending rates have fallen to record lows, investment grade bond yields have fallen by 2% or more from last year’s highs and US junk bond yields have fallen from a peak of around 23% down to around 14%. Though credit markets remain very difficult, they are moving in the right direction.

Forward looking economic indicators are showing improvement – consumer confidence in most countries is trending higher; business confidence in most countries appears to be improving; US home sales and business conditions for home builders seem to be bottoming; the Organisation for Economic Cooperation and Development’s (OECD) global leading economic indicator appears to have lost downward momentum, with a rapid improvement in its 3-month rate of change.

While none of these indicators are confirming a recover from later this year, improvements do suggest a recovery is on track.

Implications for Share Markets

We are still in recession and aftershocks from the financial crisis will be felt for a while yet. As such, periodic corrections and bouts of volatility are to be expected in share markets until the recovery actually arrives. In fact, the historical record in the US indicates that after a 37% rally (as we have seen since the March low to the recent high) there is a 70% chance of a 10% correction in the following 6 months. Capital raisings, further bank losses and rising unemployment generally have the potential to add to this likely volatility.