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Is A “Double Dip” Automatically Bad For Stocks? at Trader’s Narrative

Recently, the stock market has fixated on the lack of economic growth, or lack thereof. This is the narrative most are using the describe today’s weakness in stock prices. The G20 are more concerned about reducing their fiscal deficits and we’ll have to leave it to history to decide if this path of austerity is the right way to pull us out of a deep and persistent recession.

Right now, the ECRI’s WLI has captured the attention of traders and investors because of the steep decline it recently suffered. The decline of the US weekly growth rate to -5.8% got many worried and its further fall to -6.9% last week only helped to convince more about a coming “Double Dip”.

Last week I made a case for questioning the “Double Dip” Shiboleth. While everyone is focused intently on the ECRI’s WLI numbers, they are ignore the interpretation of this decline by the creators of the very same index. But even if we ignore this, we then have to contend with the other data that suggests this is a mere slowdown in the pace of the economic recovery, not a fresh decline into a new recession.

But if we ignore that also, we then have to ask ourselves about the connection between a “Double Dip” and the stock market. Right now, very few are asking the question but instead simply assuming that if the economy does fall into another recession, this will mean disaster for stock prices.

Whenever something captures the attention of Wall Street so thoroughly and whenever it seems that everyone is convinced of it as a foregone conclusion, I can’t help but be skeptical. This weekend I was all set to embark on a historical analysis of the previous times that the ECRI’s Weekly Leading Index had fallen into negative territory and compare those incidents with how the stock market performed going forward.

And then the bright minds at Bespoke beat me to it. So rather than re-invent the wheel, here is the result of their research showing what has happened to the S&P 500 index when the ECRI’s WLI has fallen to -5% or less:

ECRI negative SPX performance Jun 2010
Source: Bespoke Investment Group

The study covers 1968 to the present and only picks out incidents when the ECRI’s WLI fell below -5% (after being above that level for the past 6 or more months). Those criteria provide us with only 9 other similar scenarios which isn’t very many.

The average performance in the short term has been weak, although not extremely so. Over the medium term, the S&P 500 has been positive and even slightly outperformed relative to its own average. This confirms my other analysis that the equity market has lost its afterburners and entered a period of lower return (not necessarily negative return). This is also inline with what we’ve seen in the aftermath of bear markets.

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3 Responses to “Is A “Double Dip” Automatically Bad For Stocks?”  

  1. 1 Samuel

    The results indicate that the WLI drops during secular bear markets tend to lead to more consistent losses.

  2. 2 Tom Htu

    Yeah, but how many of those period were preceded by a debt crisis. It’s an apples to oranges comparison because I suspect that it is going to take longer than normal for the standard Fed playbook to work its magic.

  3. 3 roy

    Great post, but badly mistitled. As you know full well, a double dip refers to GDP, not WLI. You have demonstrated that last week’s WLI decline may not be bad for stocks. And perhaps everyone has incorrectly anticipated a recession. But here you are suggesting that a recession might not be bad for stocks. Why don’t you do the research on that question: What are the odds for the stock market keeping its gains if we have 2 quarters of negative GDP? I suspect they won’t be so ambiguous.

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