If the Stock exchange market is better at reacting than predicting, what are the implications?. Following the fundamental of CAPM , it will react sharply either upward(speculative bubbles, rational exuberance) or downward (profit tasking) as soon as available data suggest .This is so, because anything different to what it is expected, will imply expected profit corrections either upwards or downwards. So ,it is highly probable that Stock exchange markets does not anticipate properly an economic recessions, but its quick reaction to the first signals, will be key to avoid its consequences on short run returns.-
To check some numbers. During the first quarter of 2006,the stock market rate of return measured in current dollars,(www.elmercurio.com 1/4/2006) was 52,18% in Venezuela,27,49% in Russia,25,67% in China,13,03% in Germany,6,09% in Japan,4,18 in the Dow Jones (USA),8,73 in Chile and -31,54 in Dubai .In this last case(Dubai), this results shows that investors were waiting for the east American ports deal to be done, such as to increase theirs earning because of the higher market value involved in such a situation, for the all tradable goods sector, insurances companies, logistics sectors business and the like. When it happened not to be so, they reacted quickly moving away to other better alternatives.-
A second issue is the type of firms participating at the trade floor, on the stock exchange markets. In the Chilean Stock Exchange case, firms share in the price index which measures the exchange activity ,has been changing from a heavily regulated firms, which accounted for 71 % of such index in the nineties, to the 26% they have today. On the other hand , Retails firms actually have a share of 18,5% in such index , while in 1996 they had barely 3,9% .Financial services firms have increased their share form 6,2% in 1992 to 20,1% in the year 2005.( www.elmercurio.com 11/02/2006).It is obvious that the predicted power of an exchange market composed either by regulated or protected firms is null. As long as stock exchange markets broaden its business level participation , it might better represent the feeling of markets as a whole helping to improve the information available regarding markets expectations.
Keeping in mind that the nature of short run profit maximization, adapt itself to market conditions, whether good or bad, then the question is what economic information the stock market value most, when it comes to anticipate a slow down in the economy ?. For some time oil prices were the key signal to anticipate a recession. The relationship between oil prices and economic activity situation for the American economy in the last 25 years has been broke down. For every increase in oil and gas prices the American economy fall to a recession. However , because productivity has increased counterbalanced the impact of oil prices increases , actually theses increases are in the mid sixties dollars a barrel and the global economy is growing at a pace of 4% . So, oil prices increases are not a good predictor either, and beyond that signal recessions quality ,stock markets have incorporated such increases in theirs profits expectations.-
Finally ,it is hard to say without additional research, where are the data to anticipate a recession,aside from the traditional threee quartes of nefative GDP growth,(the point is how to anticipate that) , but my bet is that in the first place ,they are on the sales levels and the unemployment levels trend on medium size firms, and the bad loans index .When bad economic times are near to arrive ,medium firms size sales levels fall, unemployment rise, consumption decrease, and bad loans risks increase.-