Bad News For the Economy is No Longer Good News for the Stock Market

After underwhelming economic news, the US stock market had a panic sell off, with the Dow Jones Industrial Average and S&P 500 both falling upwards of 5%. In other words, bad news for the economy spelled out bad news for stocks.

As obvious as that sounds, it wasn’t the case for the first half of this year, where disappointing economic news, ranging from the Federal Reserve’s reluctance to cut rates to persistent inflation, has trended negative while markets were setting new record highs. The reason for the inverse relationship was that negative economic news strengthened the case for the Federal Reserve, which controls monetary policy, to cut interest rates from their 23 year highs.

This trend continued until the end of July, when a weaker-than-expected economic report triggered a selloff that caused the Dow Jones Industrial Average to slide 2,000 points over the week that followed.

What changed?

For months, disappointing economic reports fueled market rallies, as investors remained overly optimistic that it would prompt the Federal Reserve, which is a self-proclaimed data driven body.

But recent economic data trends pointed to the possibility of an economic recession. With jobless claims rising to their highest levels in a year, triggering the Sahm rule recession indicator, coupled with the ISM manufacturing index contracting for a fourth straight month, suggesting the manufacturing sector is shrinking. While this data is slightly skewed due to seasonal layoffs by auto companies to prepare for a new season of production, it still points to the possibility of a hard landing, unwinding years of cautious policy enacted by the Federal Reserve.

To put it simply, the “cracks” in the economy that once fueled optimism amongst investors are opening up, suggesting deeper problems with the US economy.

This news prompted Jerome Powell, chairman of the Federal Reserve, to confirm that rate cuts were likely on the way this fall as they scramble to reach a soft landing, where inflation cools down without triggering a recession.

Are we heading for a recession?

Not really. While the data raised concerns and put investors on edge, it is not indicative of a recession, but rather signaled stock corrections from the unprecedented 2024 rally. In other words, bad news for the economy now means bad news for stocks.

Additionally, fears of a recession are mainly due to high interest rates, which make it harder for the average American to seek loans or handle credit card debt. Moreover, Fed rate cuts are almost certain. If this is the case, it will provide a much needed boost to the tight economy and can quell fears of a recession.

Moreover, more recent economic reports reflect positive movement, with new weekly claims for unemployment benefits at their lowest levels in months. In addition, inflation continues to fall, with Department of Labor statistics reporting 12 month inflation rates fell to 2.9%, their lowest 12-month increase since March of 2021.

Conclusion

The US economy continues to be in a precarious state, where unfolding developments can steer markets in their direction. The general outlook is that the chance for economic expansion is greater than the chance for a recession. Experts remain uncertain, and a lot remains up in the air. But we can remain confident in one thing: bad news for the economy won’t be great news for the stock market anymore.

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