Recession and stock prices

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March 18th, 2009 BG Shirsat

The impact of a downturn on share prices has been varied. In the 2001 tech recession, seven out of ten sectors lost more than average (65 per cent) of their value between the Sensex peak of February 14, 2000 and low of September 21, 2001. Sectors affected by the meltdown of internet bubble of 2000 fared even worse with information, communication and entertainment sectors losing more than 75 per cent of their value in the recession of 2001.

The implication of current downturn seems to be far reaching than 2001 with eight out of ten sectors having lost more than 65 per cent of their peak value of January 8, 2008. The housing bubble in the US in 2004 to 2006 has led the current recession as subprime housing lenders defaulted due to sharp correction in property prices. The US subprime default has already destroyed $50 trillion of shareholders’ wealth across the globe since January 2008 and still there no light at the end of tunnel.

The 1980–82 and 1990–91 recessions affected valuations less severely. Only one sector lost more than a third of its value in both of these downturns (energy in 1980-82 and financials in 1990-91), and most sectors suffered losses of 5 to 15 per cent. The current recession, which was mainly caused on account of financial default in the US, has affected all consumer discretionary sectors such as automobiles, airlines, retailing and textiles. The value destruction has been across all sectors but consumer related sectors are punished more.

All the past global recessions have provided opportunity to buy equity for bountiful returns over the next few years. In 2001, tech stock prices had crashed by an average of 65 per cent with almost 98 per cent stocks witnessing value erosion. However, in the next eight years, between September 21, 2001 and January 8, 2008 valuation rocketed by over 1000 per cent. Even at the current prices, the average gain from listed securities is still a whopping 300 per cent.

This time things are different though, with almost all global indices trading at multi-year lows. As of now recovery in stock prices is very remote as all economic indicators are showing no signs of improvement, History suggests some possible indicators of the beginning of a recovery coming from the consumer sector. In three of the four most recent recessions, higher consumer discretionary and IT spending led the way.

When real operating profit growth resumes in these sectors, it may be a useful indication that the economy is turning around. However, there is very little evidence that the contraction in the US economy is slowing. The fourth quarter GDP was revised downward, showing that the economy contracted at an annualised rate of 6.2 per cent during the most recent quarter.

Things have now improved, and a bear market rally is on. The big question is when will equity markets return to normal?

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3 Responses to “Recession and stock prices”

  1. Prashant Sawant, KNG Sec LLP Says:

    Agree with Subhankar! Market going up does not necessarily mean ‘normal’ market..overall economy in terms of GDP, consumer demand, supply dynamics, market mechanism, and most imp ‘market awareness’, ethical standards of market behaviour would ensure that mkt returns to ‘normalacy’. Meanwhile, ‘greedy’ people will keep inventing diff ways to create imbalances.

  2. Omigosh Says:

    The key question is when will a recovery begin? Post-elections? What if the “aam” party that demonstrated it KNOWS how to contain the fisc for the 4-year fast track (9% plus, no less), while also giving the aam aadmi a safety cushion, and then how to let it loose for the obstacle course (chunaav season), while also winking at India Inc, loses traction? What then - so be it?

  3. Subhankar Says:

    Quite a balanced article. And then you go and spoil it all by asking that silly question at the end. What exactly is your idea of a ‘normal’ equity market? And how does one return to it?

    It is a little tiresome to find business media acting happy when the market moves up and become sad with long faces when the market moves down. Both up and down movements, and bull and bear phases, are ‘normal’ in a stock market. It has always been - and always will be.

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