E Is The Weak Stock Market Predicting A New Recession?

“The Dow has grown increasingly volatile in the past year, swinging more than 1,000 points on five days in 2018 -- something that's happened only eight times in the history of the exchange. The Dow closed down 8.7% for all of December, the worst record for the month since 1931, when Herbert Hoover was president. In one seven-day stretch, it fell by 350 points or more six times.” (Jeremy Diamond and Lydia DePillis, Trump downplays stock market swings amid growing economic anxiety, CNN, Jan 3, 2019)

President Donald Trump has downplayed last month's stock market rout -- a dive that led to the worst December since the Great Depression -- as a "little glitch."

The US Fed has been hiking interest rates, mortgage rates have been increasing, house construction is slowing, and the American economic recovery is over nine years old.

The stock market has been in a down phase for more than a year now, and volatility has increased over the past three months. Even though unemployment is at its lowest level in 50 years it is quite understandable that many are worried that the market collapse is predicting a new recession.

Those who support the predictive value of the stock market for the economy argue that since the stock market is forward-looking, current equity prices reflect expected future earnings and profits. Since corporate profits are directly linked to the business cycle, fluctuations in stock prices are thought to lead the direction of the economy.

When the economy is expected to slip into a recession, for example, the stock market will anticipate this by bidding down the prices of stocks. A second and related strand of this argument is that when the stock market is declining, investors are suddenly less wealthy and will spend less. In turn, this will slow the economy down and possibly throw it into a recession.

Nonetheless, on a historical basis it is not unusual for investors to get spooked about the economic outlook, and even though the market declines, nothing too bad may materialize. 

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