The Behavior of Stock Returns Around N.B.E.R. Turning Points: An Overview (Revision of 5-91)

Jeremy J. Siegel

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: Despite increasing criticism by economists and forecasters of the ability of the stock market to predict economic recessions, it is shown that 38 of the 41 measured recessions since 1802 have been preceded by an eight percent decline in the stock returns index. There have been twelve "false alarms" using this criterion, where stock declines have not been followed by recessions, and seven of these have occurred since World War II. Despite these faulty signals, there is a significant gain to stock investors from being able to predict turning points in the business cycle over all time periods. During the post-War period, a four month lead time in forecasting cycle turning points results in the 4.8% annual (risk-adjusted) excess return on a stock portfolio. Since World War II, stock returns have reacted three to four months earlier than during pre-War business cycles, indicating either an improvement in forecasting, or the mis-dating of earlier turning points.

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