In a 1966 Newsweek article, MIT Economist Paul Samuelson famously quipped that "the stock market has predicted nine out of the last five recessions." He was right that the stock market has a tendency to over-predict recessions, but Samuelson's remark, which was meant to defend economists and be an insult to the market's predictive powers, left out important context: as opposed to who, or what?
Since 1965, if we use declines of 15-20% in the S&P500 as a barometer for an impending recession, the stock market's "hit rate" for recession prediction is about 50-60%. If we use 25% declines as the threshold, the market's predictive powers rise to 67%. If we go all the way to 30% declines, the market's hit rate is 83%. Samuelson's claim then was too simplistic. It depends on what you use as a threshold that matters.
Economists on the other end, rarely actually predict recessions, and as the first chart below shows (of the Phila Fed's Anxious Index), it's rare for them to predict recessions even when we're in the middle of one. While they do usually ultimately see their optimism subdued when recessions are occurring, they are almost always late to the party, and typically only call recession a 50/50 shot once it's almost over. This makes their collective forecasts far less valuable for investing or policymaking. While economists tend to have disdain for the market because it moves its forecasts around more than they do, they are ignoring its signals at their own peril. It's for this reason that we think our research can be an important compliment to economists' existing processes. For more on this subject, see our note here.
How does this relate to The Curb Economist? Stock market investors are largely reacting to announcements and guidance from publicly traded companies to make their forecasts about the future. Declines in reported results and reductions in guidance for future results are real-time indicators investors use to sniff out economic weakness. We at The Curb Economist use this as our primary data input, and can therefore use the signals the stock market is sending to help predict the current and future state of the economy better and sooner than other economists.
