The stock market slide has been dizzying. Since the start of the year, stock prices have plunged by more than 10 percent, their worst start to any year on record. There is increasingly ominous talk among investors that the troubled stock market is signaling, or may even precipitate, a recession.
Ignore the talk.
While the stock market decline is disconcerting to watch, as the late economics Nobel laureate Paul Samuelson once quipped, "Wall Street indexes predicted nine out of the last five recessions."
Indeed, of the 20 market corrections - peak-to-trough declines of 10 percent or more - in the last half-century, only six were followed by recessions.
Recessions are always preceded by big declines in stock prices, as investors sniff out weakening sales and profits at big publicly traded companies. But investors are a fickle bunch, and will sell their holdings for lots of reasons that may or may not be linked to what is going on in the broader economy.
This is one of those times. A number of issues are making stock investors jittery. The collapse in oil and other commodity prices has been especially hard on the stocks of energy companies and those that sell into the energy industry. For example, the stock prices of railroad companies have been hammered as they are now moving less oil and coal.
Driving oil prices lower has been Saudi Arabia's decision to increase its oil production rather than offset the surge in output in U.S. shale fields. The world is awash in oil since the Saudis have calculated that while lower oil prices will be uncomfortable for them, they will be unbearable for higher-cost oil producers across the world, including in the United States.
U.S. energy firms have been naturally reluctant to cut production, hoping that prices would rebound, but their day of reckoning is at hand. Many of these companies borrowed too much in good times and are running out of cash to make their debt payments. Bankruptcies, mergers and acquisitions are in the offing, and production cuts will follow quickly. This should be the catalyst for more stable oil and stock prices.
While lower oil prices are bad for the energy industry, they are more or less good for the rest of the economy. The U.S. economy still consumes much more oil than it produces. Thus, if the price of oil falls, the U.S. economy ultimately wins. It may take a while, as the energy industry is quick to slash investment and jobs, but the benefits to the rest of the economy will show up.
China's economic slowdown has also created agita for investors. China is the second largest economy on the planet, after ours, and more important, many U.S. multinationals with publicly traded stocks have previously sold investors on the idea that China is key to their long-term growth prospects. If China under-performs, so, too, will they.
It is reasonable to question whether China's economy will be able to throttle back gracefully, but the almost hysterical pronouncements of China's demise are overdone. China has its problems, and it is probably overstating its growth rate, yet it is still growing strongly and has enormous financial resources: about $3.5 trillion at last count, which can be used to stimulate the economy or defend the Chinese currency.
Some stock investors are protesting the Federal Reserve's recent decision to begin raising interest rates. The Fed has indicated that it plans to raise rates slowly over the next few years to levels consistent with a well-functioning economy. It is common for stock prices to struggle when the Fed is normalizing interest rates during economic recoveries.
While rising interest rates might not make stock investors happy, the rest of us should be. It means that the economy and, more specifically, the job market are finally returning to full health. Fed officials have been clear that a necessary condition for higher interest rates is an economy that is operating at full employment. That means everyone who wants a job has one. That's a good thing even though the stock market may not fully appreciate it.
The downdraft in stock prices should also be put into a broader context. Not more than a year ago, there was substantial hand-wringing that the stock market was overvalued, or perhaps even worse, in a bubble. Fed Chair Janet Yellen ruminated publicly that many high-flying biotechnology stocks were turning speculative. It was unheard of for a Fed official to make such a pronouncement, and signaled her discomfort that a bubble could be forming, which, if it burst, might ignite another financial crisis and recession.
The recent decline in stock prices is, thus, therapeutic in many respects. Any froth in the market has been completely wrung out. Of course, there is a fine line between a healthy, garden-variety stock market correction, which is how I would characterize things so far, and a downdraft in stock prices that does real damage to the economy. It feels like we are right on that line.