Does Slowing Market Growth Mean We Are Headed for Another Recession?
Despite an incredibly bumpy start to 2020 and an ongoing pandemic, the stock market has seen incredible growth over the past couple of years. In 2021 alone, the S&P 500 gained 26.9%, while the Dow Jones Industrial Average (DJIA) gained 18.7% and Nasdaq Composite gained 21.4%.
This year has been a different story. Everything from monetary policy to geopolitical tensions have slowed stock market growth, and January ended up the worst month for stocks since March 2020. Some are worried that the market slowdown is a sign that we could be in a recession soon.
However, stock market performance is just one of many indicators of the economy’s health, and not a particularly strong one. Here’s what you need to know if you’re concerned a recession is headed our way.
Common Signs of a Recession
It’s important to understand that the stock market isn’t the same thing as the economy. “The link between the stock market and the real economy is actually pretty tenuous,” said Dan North, senior economist for Euler Hermes. “The stock market has a tendency to overreact to situations that have nothing to do with the fundamental health of the economy.”
For example, factors such as company earnings reports, changes to monetary policy, global events and financial news can cause the market to shoot up or down.
When it comes to recessions, however, there are a handful of key indicators that economists look to as signs one might be coming, including:
- Gross Domestic Product: An important measure of the country’s economic health is the GDP. This represents the total value of all goods and services created in an economy. So when the GDP slows, it could be a sign we’re headed for a recession. (A recession is officially defined as two consecutive quarters of negative GDP growth.)
- Bond Yield Curve: One of the most closely watched indicators of a recession is the yield curve on U.S. Treasuries. Historically, when the yield curve inverts — meaning short-term bonds pay higher interest rates than long-term bonds — a recession often follows.
- Corporate Profits: During earnings season, which happens quarterly, major businesses release their earnings stats. Falling corporate profits is considered a strong sign that a recession is on the way.
- Timing: That might not seem very scientific, but the economy is cyclical. Recessions occur on a fairly consistent basis. In fact, Since World War II, we’ve gone an average of 58.4 months (just under five years) between recessions.
Other indicators that can help predict a recession include the job market, inflation, consumer confidence and more.
What’s Going on With the Stock Market Lately?
One of the biggest causes of falling stock values has been recent worries over the possible invasion of Ukraine by Russia. If those tensions were to ease, North said, that negative sentiment could quickly disappear.
Interest rates are also on their way up, which negatively impacts assets such as stocks and bonds. “Rising rates make the future value of a company fall, thus driving its price down today,” North explained. “This is particularly true of highly valued stocks like tech stocks in the NASDAQ.”
Even so, the faltering stock market does not necessarily signal a recession, according to North. “There is too much going right in the economy for an imminent recession, including excess savings to fuel consumption, plenty of work in the pipeline with backorders and new orders near record highs, a need to restock inventories, a tremendous demand for labor, and several leading indicators pointing to continued growth,” he said.
Still, monetary policy decisions could lead to a recession in a couple of years, according to North. In response to the economic crisis created by the COVID-19 pandemic, the Fed implemented emergency responses, including slashing its target rate to 0% and pumping money into the economy. Fortunately, the country experienced a fast recovery by the third quarter of 2020. Yet the Fed kept those emergency conditions in place for another six quarters — “well past the time they were needed,” North said.
Now the Fed is far behind the curve on inflation, and as a result, it will have to aggressively raise interest rates in the coming year. However, North warned that if it goes too far, the Treasury yield curve may invert in 2023 or even as early as the end of this year. “A sure sign of a recession in 2024,” he said.
Jobs Report: Why Have the Estimates Lately Been So Wrong?
How To Handle Stock Market Volatility
Slowing stock market growth may not be a strong sign that a recession will occur soon, but market ups and downs happen all the time. So how can you prepare?
“The best thing investors can do is to understand what they want and need from their investments and to create a sound plan to achieve those goals,” said V. Henry Astarjian, an investment advisor with Waterstone Advisors, LLC.
Once you have that plan in place, trust and stick to it. “Where investors often run into trouble is when they get rattled by the market’s volatility and then begin to doubt themselves,” Astarjian said. “Markets will always go up and down, sometimes dramatically. Staying committed to an investment plan can help investors weather those storms.”
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