It’s usually when the stock market is in the headlines that you see a lot of chatter about the economy. And since those headlines typically occur when the market falls by a large amount, the accompanying commentary tends to focus on a potential recession.
This year, one could be forgiven for wondering what all the fuss is about. The economy is growing at its fastest pace in years (3.5% as of the third quarter in 2018) and unemployment is at its lowest level in almost fifty years.
At the same time, the stock market has been going through several more ups and downs this year than in 2017. However, last year was an anomaly and things have simply returned to normal in 2018.
Here is a chart from JP Morgan’s excellent Guide to Markets book that they put out quarterly. It shows that the S&P 500 stock market index has fallen an average of almost 14% in every year since 1980. The red dots in the chart show the extent of declines in each year, and despite those, you can see that the index has finished 29 of 38 years with a positive return.
There was a reason the noted economist, Paul Samuelson, once said:
The stock market has called nine of the last five recessions.
Now, since the 1920s, there have been ten bear markets. A bear market occurs when stocks decline by at least 20%, i.e. significant declines instead of the typical ones you see year in, year out. Think more along the lines of stock market crashes in 2000 and 2008.
Out of these ten bear markets, eight have occurred during recessions. So even the data suggests that there is a connection.
If you think about it, the stock market ought to tell you something about the economy. After all, stock prices essentially reflect how companies will fare in the future. If the ‘collective wisdom’ believes profits are headed downhill, it stands to reason that a softer economy (or one that is in a recession) will be responsible. Of course, investors can be wrong and have been wrong in the past.