Posted on Seeking Alpha at http://seekingalpha.com/article/115470-should-you-buy-stocks-before-the-economy-recovers

You hear it all the time:  “you need to own stocks before the economic recovery begins.” “the S&P (Ticker SPY) will recover 6 months before the recession ends;”  “the market is a discounting mechanism;”  And, some of this is true.  The market is clearly a discounting mechanism, but there is no evidence proving that it discounts well ahead of an economic trough.  50 years ago this might have been true, but this ain’t your granddaddy’s stock market.

In the day of high-speed technology, discount brokers, and real-time news the markets move quickly and discount news almost as fast.  The markets have undergone a phenomenal technological upgrade in the last 20 years.  The introduction of discount brokers has made investing more mainstream.  The internet makes news available immediately to an incredible number of people.   News is disseminated immediately and millions of stock orders are placed within seconds.  The result has been an evolution in the approach to investing.

Technology has created an entirely new kind of investor: a short-term investor.  In the 1950’s, when Benjamin Graham became the grandfather of “buy and hold investing,” it was difficult to trade stocks.  The news was slow (hello Pony Express!), orders were difficult to place (good-bye Merrill Lynch – literally!) and investing was a game for the upper class.  It  didn’t make any sense to buy a stock for 3 months and sell.  But the buy and hold mantra has lost its grip on the investing public as the market has evolved.  Investors don’t have to  hold stocks and wait for the dividend payments to show up once a quarter in their mailbox.  The free market itself evolved and opened doors to a faster more furious kind of investor and ultimately a market with a shorter timeframe.  The result is a stock market that doesn’t discount as far in advance as it once used to – and the evidence is clear in the last 20 years.

The main influence in this evolution to a market with shorter duration has been corporate interaction with the public.  As technology has evolved and news has become more readily available, companies have become more focused on interaction with  investors.  Investors demand answers in real-time and companies are more and more willing to feed the short-term hunger of investors.  The result has been a sharp focus on quarterly reports.   This focus on quarterly reporting has given investors the ability to react to news more quickly.  You don’t have to wait until the fiscal year-end to see that Crocs’ (Ticker: CROX) earnings fell off a cliff.  You can sell the second you read the 10-Q on the internet.

The following chart corroborates the evolving market hypothesis.  In the two major recessions during the modern market (‘91 & ‘01), the market actually bottomed in unison or after GDP bottomed.  In the ‘91 recession, GDP troughed at -3% in Q4 of 1990.   The stock market did not make a rebound until the 4th quarter of the same year.  During the ‘01 recession, GDP troughed at -1.4% in Q3 of 2001, but the market did not bottom for another year.

Clearly, two recessions is far from enough data to come to any sort of airtight conclusion, but the lesson is clear: be wary of anyone who tells you you need to buy stocks before the economy begins to recover; it’s the second mouse that gets the cheese.

Sources:

http://www.bea.gov/

http://www.standardandpoors.com