How the wave of selling can kill economic expansion



A strong rally in stock prices on Friday gives bullish investors new hope for future gains, but other great daily advances in recent months have often been followed by declines to new lows. Meanwhile, analysts at Bank of America Merrill Lynch warn that falling stock prices, spikes in volatility and evaporating liquidity in securities markets can trigger a general economic contraction. ” We think that [volatility] can no longer be considered noise for reasons of illiquidity or automatic trading, ”writes BofAML in a recent report cited by Barron.

The S&P 500 Index (SPX) posted an increase of 3.4% for the day on January 4, but it remains in a correction, now 13.9% below the record set in September 2018. If BofAML is correct , a vicious cycle can result, as recessions tend to trigger bear markets or worsen those that are already underway. The table below shows the longest recessions in the United States since 1929, from economic peak to trough.

The longest recessions in the United States since 1929

  • 43 months from August 1929 to March 1933
  • 18 months of Dec. 2007 to June 2009
  • 16 months from November 1973 to March 1975
  • 16 months from July 1981 to November 1982

Source: National Bureau of Economic Research (NBER)

Importance for investors

The first of the recessions listed above was the onset of the Great Depression of the 1930s, and the stock market crash of 1929 occurred in its early stages. The last recession above was punctuated by the financial crisis of 2008, and was accompanied by the latest bear market of the S&P 500.

“We are entering a recession. I think it will be this coming year,” said David Rosenberg, chief economist and strategist at Toronto-based Gluskin Sheff + Associates. CNBC. “We have more than an 80% chance of a recession simply on the basis that the Fed is tightening its policy,” he added. “This tightening of financial conditions that we have seen in the markets will eventually have a cascading effect on the economy for the first quarters of this year,” he concluded.

CCC-rated high-yield bonds, a particularly risky segment of this market, are trading at struggling prices, Barron notes, indicating that investors fear payment defaults. Meanwhile, BofAML predicts the default rate on high-yield debt will be 5.5% in 2019, up from 3.25% in 2018, adds Barron’s. Even if they don’t see a “real [default] credit cycle “is still emerging, BofAML analysts Oleg Melentyev and Eric Yu see it as one of many indicators that the credit cycle is peaking and preparing for a contraction., political tensions in the United States and Europe and trade wars.

Personal consumption spending, also often referred to as consumer spending, accounted for 68% of U.S. GDP in the third quarter of 2018, according to the Federal Reserve Bank of Saint-Louis. While personal disposable income is the primary driver of consumer spending, personal wealth is another key factor. A declining stock market can negatively impact the economy as a whole by lowering consumer spending, as well as limiting the ability of companies to raise new equity.

Look ahead

According to a model developed by Jonathan Wright, a professor of economics at Johns Hopkins University who served as a special adviser to the Federal Reserve, the odds of a recession starting in the United States in 2019 are just 2.4%, through In search of the alpha. However, a recent survey of chief financial officers (CFOs) of US-based companies found that more than 80% of respondents expect a recession to begin by 2020, according to Money magazine.

Other notable observers who believe a recession will likely begin before the start of 2021 include, according to the same story in Money magazine: billionaire hedge fund manager Ray Dalio, former Federal Reserve Chairman Ben Bernanke, Mark Zandi, the chief economist of Moody’s Analytics, the strategy and economics teams of JPMorgan and BlackRock, as well as the economist Nouriel Roubini, who predicted the financial crisis of 2008.

The chances of a US recession starting by 2020 are 50%, in the opinion of former US Treasury Secretary Lawrence Summers, per CNBC. The probability is 40% according to more than 100 economists surveyed by Reuters. Another Reuters poll of more than 500 fund managers, economists, currency analysts and equity strategists indicates a widely held belief that the US economy is at or near a peak, and that a slowdown is imminent.

Finally, note that the stock market crash of 1987 is the most recent example of a bear market that was not accompanied by a recession. The dotcom crash of 2000-2002 began while the US economy was still expanding, and a recession developed thereafter. Meanwhile, the recession of 2007-2009 and the bear market that accompanied it was partly triggered by the subprime mortgage crisis of 2007 and then worsened by the more widespread financial crisis of 2008.



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