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Markets crash, recession looms

Stock markets are often said to be a leading economic indicator, capable of predicting the direction of economic activity in the coming months. If that is the case, continued sluggishness in markets could herald an economic future that is far from bright and even stormy.

Posted at 6:30 am

It is that, decidedly, the stock markets do not give signs of respite to investors and enter the second half of the year as they closed the first half of 2022.

Those hoping Monday’s meager gains on the Toronto Stock Exchange would mark the start of a possible trend reversal were confronted with an abrupt reality check on Tuesday when points gained the previous day were abruptly erased. The 8% drop in oil prices rattled the Canadian index, with energy sector stocks taking a hit.

As we know, the US stock market posted its worst first-half year returns since the early 1970s. The S&P 500 index is down more than 24% since peaking six months ago.

For its part, the S&P/TSX index continues the decline that began three months ago. It had registered, until Tuesday, a fall of almost 15% in its value. And nothing seems to want to stop this downward movement, while growing fears of a recession have only fueled the momentum of investors who want to sell their securities in recent days.

Given such a context, one can then ask if the bearish behavior of the markets is currently a leading indicator of economic activity or if it reflects the anticipated deterioration in the general economic situation for the reasons that the e knows about high inflation and the consequent rise in interest rates.

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

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

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

The 1962 bear market with a 28% drop, the 1966 bear market with a 22% drop and finally the famous 1987 crash with a 33.5% devaluation were not followed by a marked decline of economic activity. activity, therefore they were not a harbinger of a recession.

Benefits to see

The situation in 2022 is special. The sharp correction in the first half was primarily the result of a revaluation of extremely high valuations in many stocks. We only have to think of the values ​​of Tesla, Apple or Amazon, which fell sharply because they were equally overvalued.

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

Until then, there are several other leading indicators of economic activity that will give us a good measure of the risks or not of a recession in the United States and possible contagion in Canada.

Currently, of the 17 main indicators, there are four that sound the alarm of a possible recession. In addition to the stock markets, there is the price of copper, 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 will have to look at the next data on the labor market and see, for example, if companies are using employment agencies less”, observes Matthieu Arseneau.

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

In short, the risks of recession are more linked to the increase in inflation than to the behavior of the stock markets, and the way in which we manage to reduce the increase in the cost of living will be decisive for the future.

Ironically, the stock markets, which are supposed to be the indicators of a possible recession, have been pulling back for some time on the apprehension of such an eventuality.

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