Parsing Yesterday’s Stock Market Slide

Analyts at ANZ agree, opining that “equity markets are locked in a sharp sell-off, with concern around how far yields will rise, warnings from the IMF about financial stability risks and continued trade tension all driving uncertainty.”

The question from a US perspective is whether an extended slide in stock prices is warranted? Quite a lot of the answer will be based on the economy. For the moment, the numbers still look encouraging. Recession risk remains virtually nil, as noted in this week’s update of the US Business Cycle Risk Report, based on data published through Oct. 5.

Meanwhile, the outlook for the immediate future remains upbeat, based on the latest nowcasts for third-quarter GDP, which is due later this month’s in the government’s preliminary Q3 update. The Atlanta Fed’s GDPNow model (as of Oct. 10) points to another strong quarterly gain, projecting a 4.2% rise in output for the three months through September. The New York Fed’s Q3 nowcast (Oct. 5) is considerably softer via a 2.3% estimate, but it’s safe to say that both numbers strongly suggest that the nine-year US expansion will roll on for the foreseeable future.

If the economy continues to grow, there’s a reasonable case for seeing any slide in stock prices as a buying opportunity rather than a signal that an extended bear market is upon us. Ongoing rises in interest rates could temper a rebound in equities, but as long as yields are trending up due to solid economic activity it’s reasonable to assume that the big picture for stocks remains productive. Expected returns may no longer be stellar, although the further stocks fall the better the outlook.

The usual caveats apply, of course, but the first order of business for putting a market tumble into perspective is monitoring how the macro trend evolves. By that standard, it’s premature to assume the worst. By contrast, if the incoming data reveals that the macro profile is deteriorating, we may be looking at more than a “normal correction,” as US Treasury Secretary Steven Mnuchin characterized yeseterday’s sharp decline in the stock market.

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