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Does a Stock Market Downturn Signal a Recession?

Posted By timparker On 10/03/2011 @ 2:14 pm In Investing | 2 Comments

If you believe everything that the media says, you would think that when the stock market has a bad day, week or month, the economy is on a downward trajectory to disaster. Although large scale sell offs in the investment markets shouldn’t be ignored, it’s important for not just investors but also all of the world’s citizens to remember that the investment markets may predict a recession but not necessarily.

The Media

Network news channels, internet news aggregates and armchair economists watch the investment markets much more closely than ever before. Everybody still has memories of 2008 and 2009 when markets were in a freefall. This eventually led to a recession but more importantly, it eroded home prices, laid off workers, and stole a lot of money from retirement and investment accounts. The media often does an irresponsible job of reporting investment market news. Headlines like “stocks in freefall”, “Gold plunges” and “world markets in panic over European worries” add to the hysteria that is still left over from 2008.

It’s important to remember that the media has the job of keeping you engaged in their product. They aren’t going to report that the stock market is down because it is technically oversold or because the Relative Strength Index is at a level that always leads to a correction that could very well set up the next leg higher in the market. They aren’t going to tell you that Dow Theory paints a picture of healthy markets having cycles that lead it up on some days and down on others. Finally, they may forget to say that even with violently swinging markets, often the longer trend shows little movement.

History

History shows us that not all investment market downturns lead to a recession. Take the 1987 stock market crash as an example. It wasn’t until 1991 that we experienced another recession and before that the last recession ended in November of 1982. Sometimes a stock market crash is a healthy act for a market. It may restore fair value bringing prices down allowing more investors to put money to work. Of course, the last big crash led to a recession that would last until 2010 so investors and consumers are understandably worried.

The best defense is…

A good offense, as the saying goes. Nobody knows when the next recession will arrive but we know how to prepare for it and luckily preparing for a recession is by practicing good financial habits. Stay as free from debt as possible and don’t follow the advice of the U.S. Government and spend any extra money you have. Build up an emergency fund and make yourself as marketable as possible by having an education. Having one degree drastically decreases your chances of unemployment but if there is something else that you’re interested in, take some classes on the side. A great investor has a diversified portfolio. The more diversified you are as a person, the more prepared you are. That doesn’t mean try to be a master of everything but having options besides your current career makes you even more recession proof.

Bottom Line

Don’t believe everything you hear. The country may dip in to another recession in the near future. Nobody knows but those who have prepared their financial house can much more easily weather the storm. Nobody will say that paying off debt and saving money is easy but it’s necessary.


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