Economic & Market Cycles
Economic cycles are loosely defined as fluctuations in growth patterns caused by overall economic and financial trends, competitive forces as well as the nature of supply and demand. While these cycles may be predictable in pattern, they are rarely predictable in duration.
The current equity market is no exception. While the most recent recession was the longest since World War II (18 months), the market has exhibited familiar patterns relative to past recessions – notably the 1980, 1982, 1991 and the 2001 recessions. For instance, the market experienced a 4.12% increase in the six months following the recession end in June 2009 and a 9.23% return after 12 months. (See Exhibit 6) The exhibit shows that on average, the six-month return following a recession end is 4.77% and 6.99% after 12 months.
Looking back on the four past recessions, bear markets, on average, have bottomed four months prior to the official end of the recession. Another familiar pattern has been the performance of mid-caps relative to large caps (represented by the S&P 500) around the market bottom. The exhibit clearly illustrates that as the market approaches the bottom, mid-caps have tended to underperform large caps, but once the recession end is established, mid-caps have progressively outperformed large caps as the economy recovers. This illustration of the economic cycle suggests that mid-cap stocks tend to underperform large caps when investor fear and risk aversion are rising, but steadily outperform as investors regain confidence in the market.
EXHIBIT 6: Average Mid-Cap/Large Cap Ratio Around the Last Five Recession End Dates
Source: Ned Davis Research, 12/31/10
The “Change in Ratio” compares the ratio between the value of the mid-cap index and the large cap index over designated time periods. A positive number indicates that mid-caps outperformed large caps over the period and a negative number would indicate that large caps outperformed mid-caps. For example, the ratio of the two indexes at the end date of the 1980 recession was 10.07. Six months later, the ratio was 10.24. The ratio increased by 1.69%, indicating that the mid-cap index outperformed the large cap index by 1.63% over the period.
Bear market bottoms have occured an average of four months before recession end dates.
Monthly Data Starting in 1978
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Mid-Cap = Russell Midcap Index
Large Cap = S&P 500 Index
Past performance is not indicative of future results.
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Equity securities (stocks) may be more volatile and carry more risk than other forms of investments, including investments in high grade fixed income securities. Mid and small capitalization funds typically carry additional risks since smaller companies generally have a higher risk of failure.
Indexes are unmanaged and investors cannot invest directly in an index.