Chart of the Every Other Tuesday – American Hysteresis
There are several theories about why economic hysteresis occurs.
1) A financial crisis can trigger institutional changes, like tougher capital requirements, that can affect output levels.
2) To save on costs, firms may cut back on R&D during recession, which leads to lower productivity levels than had there not been a recession.
3) In the labor market, the high extended unemployment associated with a recession may cause some workers to become outmoded, and drop out of the labor force permanently.
Since one method of valuing a company’s stock price is the cumulative representation of future earnings, this observed hysteresis suggests that investors should taper their expectations about future market returns. But it’s always dangerous to judge future earnings on historical data, and political forces could reverse this trend. Time will tell.
- Stephen Zentner
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