US Recessions and the MSCI World Index

Mar 13, 2008
Recent market talks are around the fears of recession in the US. Although finance is often considered as sort of an exact science, it however cannot avoid the influence of the state of anxiousness by market players and investors. That is why a behavioral finance matters and needs to be neutralised by showing the real facts in the financial markets and a good sense to answer if a US recession is really going to bring down the entire world financial market in the long term.

Periods of US recession and the definition

The state of US recession period is officially announced by the National Bureau of Economic Research (NBER). Since 1970 there have been 5 states of recession in the US, as follows :
• November 1973 to March 1975
• January 1980 to July 1980
• July 1981 to November 1982
• July 1990 to March 1991
• March 2001 to November 2001

The NBER defines that
“A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.”

The informal recession definition is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters.

Relationship between recession and stock market decline

There is a confusing logic in relationship between recession and stock market decline: does a recession cause a bearish market or the other way around? The exact answer is that the recession comes first and the bearish market after. In a recession, analysts would see the value of companies is declining therefore the stock prices may fall. However, some classic strategy suggests that investment in the consumables sector may be a recession-proof investment since people still buy those products, recession or not.

If the recession comes first and the bearish market after, how can we explain the states of US recession in July 1990 to March 1991 that came 3 years after the 87 crash? Many analysts argue that the Crash was mainly caused by a programmed trading system and psychology factor that beyond the economic factor of an exact finance. The “quants” (quantitative traders) who developed a computerised trading system that automatically created a sequence of selling positions might had been to blame, or it could had been the investors who were psychology weak and then fell into selling positions.

How strong is US recession influence on global market?

Another question to answer: does US recession strongly influence the global financial market, particularly Australia and NZ markets? It may not be. Asian countries like Japan, China, South Korea and others have been the dominant trading partners for Australia and therefore NZ for the last decade competing trading flows with the US. This recent economic decoupling theory may explain how US recession may be absorbed by growth in the competing countries (Asia) as maintaining trading flows with the third trading counterparts (Australia/NZ).

Some simple examples: the US recession may not affect New Zealanders to stop buying stuff from the Warehouse stores, but Americans to visit their Walmart stores. New Zealanders are not going to disconnect their Telecom line at home because of the US recession.

The recent subprime trouble in the US economy may be likely to influence ASX and NZX in terms of market psychology rather than concluding a good excuse and common sense that Australian and NZ companies should decline in value because of it. The fundamental assessment of companies’ value seems to be flawed in the short term.

Unfortunately, the recent January big drop in Asian and European markets is however breaking the belief of the decoupling theory. Investors and market players are then more aware of the true impact of US recession on the global financial market.

Market randomness over recession period

It seems some finance and economics theories try to explain and justify the prediction of world’s share market trend in the future. However, contradictions, unpleasant facts and non-economic factors may affect one’s prediction and there is only one underlying theory that can explain all this, i.e. randomness and stochastic.

Therefore, it is important to show some historical fact to see the ex post impact of US recession to the world financial market by taking a closer look at the historical data of popular benchmark of the world financial market, the MSCI World Index. The goal is to conclude that randomness in the share markets may be likely to drive the prices up in the long term regardless recession.

The conclusion of this can be easily understood by paying attention to the following chart, which show the period of US recession and the MSCI World Index. The fact is, in the time frames of 10-15 years the US recessions seems to have been driving the ex post movement of the world share market up. Therefore, recession is not a measure of uncertainty in stock market. Or, is it just because the market randomness factor always win over the recession factor?

1977 to 1987: two recessions and 280% return

A decade before the stock market crash of 1988, and despite the two recession periods were defined in 1980 and 1982, the MSCI had been dramatically increased by 280% return.

1987 to 1997: one recession and 135% return

After all, the MSCI index still increased by 135% despite the 1991 US recession was occurred.

1997 to 2007: one recession and 92% return

Regardless the Technology Crash 2000-2002 and the “War on Terror”, and despite the 2002 US recession, the MSCI index still increased by 92%.

The best example of the MSCI Index Fund managed in NZ is AMP Investments' World Index Fund (WiNZ)

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