Lessons From the 1990-1991 Recession

By James B. Stewart

GIVEN ALL THE gloomy media coverage, you don't need me to tell you that we've just come through the worst quarter for the stock market since 2002 and the Sept. 11 attacks. Much of the media has been positively wallowing in the bad news.

As an investor, I love this.

Not the bad news, mind you. What I like is the pervasive bearish sentiment, fanned by the media, which could be setting the stage for a prolonged rally.

Let me stress that no one, including me, knows where stock markets are going next. All we know for certain is where they've been. And if you look closely, as I have, you'll see that things may not be nearly so bad as those quarterly results suggest.

Let's start by breaking the quarter into three months. No doubt, January was a terrible month. February wasn't much better. But March, just completed, was not bad at all. The Nasdaq, S&P 500 and Dow Jones Industrial Average were flat.

That's pretty remarkable, considering it was just two weeks ago that investment bank Bear Stearns (BSC) was teetering on the brink of collapse and had to be rescued amidst widespread concerns for the stability of the financial system.

The current financial crisis has often been compared to the collapse of the junk bond market, savings and loan crisis, and recession of 1990-91. Some prognosticators have been saying that the current crisis may be much worse, but I don't yet see any convincing basis for that. I lived through the earlier recession, wrote a good deal about the underlying causes, and have a pretty clear memory of what it felt like. There were huge layoffs on Wall Street and much anxiety about the stability of the banking system. Savings and loans were failing everywhere. Real estate prices slumped. (In Manhattan, so far unscathed by the recent real estate collapse, they plummeted.) Only with benefit of hindsight was that recession deemed to be "mild."

How did the stock market behave during that period? The recession began in July 1990. Stocks suffered steep declines in August and September. They bottomed in October, which turned out to be the low point of the recession, then recovered to end that month with just a modest decline. They soared in November, rising approximately 6%. The recession itself didn't end until April 1991, seven months after stocks began to rally.

No one knows for sure if we're now even in a recession, but let's postulate that we are, and that it began in December. We won't know for months, but recent data suggests that it's a reasonable assumption. The GDP grew by a measly 0.6% in the fourth quarter. Considering it was still expanding in October and November, it may well have begun to contract in December.

If that's the case, the stock market has traced a remarkably similar course to 1991. December 2007 corresponds to July 1990. All the major averages suffered steep declines in January and February 2008, the months which correspond to August and September 1990. Averages bottomed in March and then made a modest recovery, just as in October 1990. If this pattern continues, the rally will gain steam this very month and stocks may record their best gains of the year.

As in 1990, this wouldn't mean the recession is over — on the contrary. The biggest rallies come during the last months of a recession, not during a recovery. By then investors have missed the biggest gains.

Will history repeat itself? The saying is that it never does, but the fact is we won't know for a while. My point is that all those pundits talking about what a terrible quarter we just had don't know the future either. They could have said the same thing in 1990, with the market on the brink of a big rally and a historic decade for stock market gains.