Markets sink, recession looms

Stock markets are often seen as leading economic indicators that can predict the direction of economic activity in the coming months. If so, the continued sluggishness of the markets could herald an economic future that is far from rosy and even quite stormy.

Posted at 6:30am

It is that the stock markets are decidedly not giving investors a rest and are entering the second half of the year as they have finished the first half of 2022.

Those who had hoped that Monday’s meager gains on the Toronto Stock Exchange marked the beginning of a possible trend reversal were given an abrupt reality check on Tuesday when points earned the previous day were abruptly erased. The 8% drop in oil prices rocked the Canadian index, with stocks in the energy sector suffering.

As is well known, the US stock market posted its worst return since the early 1970s in the first half of the year: the S&P 500 index has fallen by more than 24% since its peak six years ago.

For its part, the S&P/TSX index continues its slide that started three months ago. As of Tuesday, it had lost nearly 15% in value. And nothing appears to be stopping this move lower as mounting recession fears have only fueled investor selling momentum over the past few days.

Given such a context, one can therefore wonder whether the bearish behavior of the markets is currently a leading indicator of economic activity or whether it reflects the expected deterioration of the macroeconomic situation for the reasons that the e know about high inflation and the consequent ones rise in interest rates.

A little reminder to start. Since 1900, the dozens of bear markets in the United States have culminated in a recession 70% of the time.

Matthieu Arseneau, deputy chief economist at the National Bank, reminded me of this joke by American economist Paul Samuelson, who pointed out in 1966 that bear markets had predicted nine of the last five recessions…

“Today we can observe that since the early 1950s, the stock markets have predicted 11 of the last 8 recessions in the United States,” observes Matthieu Arseneau.

The 1962 bear market with a 28% drop, 1966 with a 22% drop, and finally the famous 1987 crash which resulted in a 33.5% devaluation were not followed by any significant economic downturn activity, so they were not a harbinger a recession.

to see profits

The situation in 2022 is a special one. The sharp correction in the first half of the year was mainly the result of a re-rating of extremely high valuations for many stocks. Just think of the stocks of Tesla, Apple or Amazon, which fell sharply because they were just as overvalued.

“We have to wait for the next financial results in the next quarter to see whether the financial situation of companies has really deteriorated and whether this confirms the thesis of a strong economic slowdown,” emphasizes the National Bank economist.

Until then, there are several other leading indicators of economic activity that will give us a good measure of the risks of a recession in the United States and possible contagion in Canada.

There are currently four out of 17 important indicators that sound the alarm of a possible recession. In addition to the stock markets, there is the copper price, the University of Michigan Consumer Confidence Index, and the Small Business Confidence Index.

The other indicators are neutral or reflect a favorable economic climate.

“We’re going to have to look at the next data on the labor market and see, for example, whether companies are using fewer job agencies,” observes Matthieu Arseneau.

A growing number of observers even believe that the US Federal Reserve could slow the pace of rate hikes to ensure a soft landing in economic activity, which would help stock markets recover.

In short, the risks of a recession are more related to rising inflation than to stock market behavior and how we manage to contain rising cost of living will be crucial going forward.

Ironically, stock markets, which are supposed to be indicators of a possible recession, have been retreating for some time, fearing such a possibility.

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