World Economy

Stock Market Panic Unpredictable

Stock Market Panic Unpredictable  Stock Market Panic Unpredictable

You’ll go broke trying to predict stock selloffs by looking at the economy: the tell-tale evidence is rarely there. But looking for clues to the economy in a stock selloff–that actually works.

So what inferences can economists draw from the past month, when the Standard & Poor’s 500 Index fell 12% in the worst tumble since 2011? To summarize, while equity losses suggest odds of a slowdown in the US have risen, they’re not yet severe enough to incite panic, Bloomberg reported.

The findings may be soothing in a market where the first 10% correction in four years is stoking anxiety over China and the Federal Reserve. While nobody knows how far stocks will fall, at the moment there’s nothing in their price action alone to refute reports showing everything from US employment to housing and auto sales are improving.

“I still see a recession as a really distant prospect,” said Daniel Morris, senior investment strategist at BNP Paribas Investment Partners in London, which oversees 532 billion euros ($603 billion). The firm bought emerging market debt during the August rout while concluding it was too early to add equities.

“One scenario would be a hard landing in China that somehow spread through financial repercussions and aftershocks,” Morris said. “But the probability of that happening is still quite low.”

 41st Correction

The retreat that erased more than $2 trillion from equities at the market’s low marks the 41st time since 1927 that the S&P 500 has declined 10% or more from a 52-week high. Of the previous 40, most proved to be temporary–and only 13 came within a year of a two-quarter contraction in gross domestic product.

Much more ominous are bear markets, the 20% drops that have hit American stocks 13 times since the Great Depression. Ten of them preceded US recessions and only four recessions occurred without a bear market warning, according to data compiled by Bloomberg. At its worst level on Aug. 25, the S&P 500 needed to fall another 8% to meet the threshold.

To be sure, not every bear market arrived at 20% before a recession started–though they usually got there before anyone realized one had begun. For example, the plunge in stocks that began in October 2007 didn’t qualify as bear market until July 2008.

 Best Forecaster

While economists surveyed by Bloomberg don’t anticipate a contraction any time in the next two years, Leuthold Group says the stock market will tell the tale. Since the 1940s, the S&P 500 has posted an inflation-adjusted loss of 9% in the 12 months leading to a business cycle top, according to a study by the Minneapolis-based firm. Over the 12 months through August, the index was down 2% after adjusting for inflation.

“Recession risks will escalate sharply if this loss reaches double digits, regardless of current fundamentals–including the Fed’s policy response,” Doug Ramsey, the chief investment officer of Leuthold, wrote in a report published last week. “With Fed policy still in experimentation mode, the best economic forecaster might be the stock market itself.”

With central banks from Europe to Asia pledging monetary stimulus, it’s hard to see the equity market and economy doing worse than they did four years ago, according to David Kahn, managing director at Convergent Wealth Advisors in Los Angeles.

Recession fears heated up in 2011 as the US lost its AAA rating at S&P, driving stocks to a 19% decline that almost ended the bull market. As the Fed stepped up bond purchases, stocks reversed all their losses in five months and the economy kept growing.

Economists expect the US economy to accelerate to 2.7% in 2016, up from 2.3% this year, according to the median estimates compiled by Bloomberg. While growth is picking up, never before has a bull market occurred without GDP exceeding 3% in any year.