This year, the financial world has been confronted with a lot of volatility and unanswered questions.
We’ve also been inundated with predictions that the US economy is nearing a recession.
It may be easy to conflate the two, especially since full-blown bear markets (a drop of 20% from recent highs) have happened outside of a recession only twice since 1900.
Considering the level of the current stock drop, however, it’s probably not advisable to use it as evidence that a recession is nearby.
“[M]arkets are more forward-looking, on average, than the economic data, raising the possibility that the sudden sell-off in equities is a harbinger of significant weakening,” Jim O’Sullivan, chief US economist at High Frequency Economics, wrote in a note to clients this week.
“However, markets can also be quite volatile, with lots of mid-cycle false alarms. Subsequently reversed declines in the S&P 500 of 10% or more during a cycle are not unusual — including a couple of times during the current cycle, most notably in 2010 and 2011.”
“Did you know that the stock market has predicted 27 of the past 11 recessions?” Gluskin Sheff’s David Rosenberg quipped on Friday.
If you’re more statistically inclined, Ian Shepherdson of Pantheon Macroeconomics ran a regression for stock market performance and GDP.
Spoiler alert: They aren’t very correlated.
“We cannot change our forecasts every time the stock market swoons, just as we don’t change our views every time it rises,” Shepherdson wrote in a note to clients.
O’Sullivan and Shepherdson both said that the labour market is a much more important indicator of a recession. Their assessment is that, even with the recent weakness in jobless claims, American workers are in good shape.
The stock market looks bad, but based on this data, it’s been this bad in the past and didn’t end in doom.
“Last year’s correction was also largely reversed,” concluded O’Sullivan. “We are counting on this episode being temporary as well.”