It’s economists vs. the stock market. Economists generally don’t forecast a recession anytime soon. The stock market does — or at least that’s one plausible interpretation of its recent roller-coaster behavior. Who’s right? We’ll know in a few months. Meanwhile, the dispute highlights the incomplete nature of the present recovery, which has lasted a long time but, to millions of Americans, still feels unsatisfactory.
Economists have long disparaged the stock market’s predictive powers. They like to quote the late Paul Samuelson (no relation to this writer), a Nobel Prize winner, who once said that the stock market had forecast nine of the last five recessions — a biting verdict on the market’s clairvoyance. It’s true that modest stock “corrections,” declines of 5 percent or 10 percent, haven’t foretold recessions. But that’s not true of bear markets, conventionally defined as declines of 20 percent or more.
Writing in Real Clear Markets, Brookings Institution economist George Perry notes that, by this standard, there have been seven bear markets in the past 50 years, and five of them have been associated with recessions. The recessions began in 1969, 1973, 1981, 2001 and 2007. Bear markets in 1966 and 1987 were not followed by recessions. Also, recessions in 1980 and 1990 were not predicted by bear markets.
A falling stock market may both reflect and cause a weakening economy. Investors and stock analysts may spot deteriorating business conditions — slowing revenue and profits, higher inflation or overinvestment in key sectors — before the general public does. Worries now center on the possible spillover effects of slower growth in China and other “emerging market” countries. Low oil prices could also force some producers to default on loans, hurting banks and other lenders.
Faltering stocks can also harm the economy directly. Eroding confidence is an obvious channel. This is related to the “wealth effect.” When shareholders — concentrated in the richest fifth of households — feel poorer, they spend less. (The opposite is also true: When a rising market makes them feel richer, they spend more.) The same is true of businesses. A declining stock market may diminish investment in machinery or buildings by making it harder to raise funds.
How does today’s market compare to these historical benchmarks?
By the Standard & Poor’s index of 500 stocks, the market’s recent peak occurred May 21 at 2,130.82. At the market’s close Friday, the index had dropped to 1,864.78, a decline of about 12 percent. This suggests that, though the economy may slow (it already has), it won’t succumb to recession. That’s usually defined as two consecutive quarters of economic contraction. However, another index is closer to the historic danger zone. The Wilshire 5000 index covers more stocks. Since its peak on June 23, it has fallen by 15 percent, representing a paper loss of $4 trillion, says Wilshire.
Still, many economists doubt we’re entering a recession. Stocks have overreacted to a few bad reports, they think. The recovery is strong enough to neutralize pockets of weakness — for example, soft exports dampened by tepid growth abroad. “The economic growth cycle remains on track,” Joseph Carson, economist for the research firm AllianceBernstein, recently told clients in a report.
Carson relies heavily on three indicators to gauge the economy’s strength — the index of new manufacturing orders from the Institute for Supply Management (ISM), reflecting the factory sector; new building permits, reflecting housing construction; and initial claims for unemployment insurance, reflecting the job market. All three, he argues, signal continued economic expansion.
The ISM index was 51.5 in January (a reading over 50 indicates expansion), and growth characterized many industries: metals, plastics, chemicals, computers and cars. Building permits have more than doubled since the trough of the Great Recession and, in late 2015, reached their second highest level since 2007. Finally, jobless claims are running below 300,000 a week — lower than before the Great Recession.
Perry agrees. He noted that last year “real” (inflation-adjusted) disposable income rose 3.5 percent and that private-sector jobs grew an average of 211,000 a month. These gains don’t “indicate a weakening economy that would call for a bear market in stocks.”
One thing is certain: Time will settle this debate.
Read more from Robert Samuelson’s archive.