An Economic 'Shock' Could Derail the Bull Market

Robust global economic growth has been a key underpinning of the bull market in stocks. But there may be too much of a good thing going on right now. "When lots of countries are growing strongly, the global economy is at its most vulnerable, thanks to heightened interest rates and financial risks," according to Stephen King, senior economic adviser at multinational banking firm HSBC Holdings PLC (HSBC), as quoted by Bloomberg. Research from HSBC indicates that every period of strong synchronized global growth since 1990 has been followed by an abrupt economic shock, per Bloomberg. Economic shocks that morph into recessions, meanwhile, frequently touch off bear markets.

These concerns come against a background of rising speculation that the Federal Reserve may decide to raise interest rates today, Wednesday, March 21, as reported by Reuters. In that vein, Fitch Ratings indicates that "booming" economic conditions worldwide make it likely that various central banks around the globe also will raise rates, per Bloomberg. If so, such increases may jolt investors. For their part, Investopedia's millions of readers worldwide are registering high levels of concern about the securities markets, as measured by the Investopedia Anxiety Index (IAI).

Recent Post-Boom Shocks

The world economy is enjoying its strongest and broadest expansion since 2011, and the OECD has raised its forecast of annual global GDP growth to 3.9% in both 2018 and 2019, Bloomberg says. Global growth rates of 3.9% or more have been achieved on eight previous occasions since 1990, per HSBC and Bloomberg, and the shocks following them have included, for example: a credit crunch recession in the U.S. in 1990; a bond market collapse in 1994; the Asian Financial Crisis in 1997; and the Great Recession that began in 2007, after world GDP growth peaked at 5.6%. Accompanying the Great Recession were the financial crisis of 2008 and a bear market that knocked 56.8% off the value of the S&P 500 Index (SPX).

Recessions and Bear Markets

"Neither longevity [of a bull market] nor high stock prices, nor political turmoil usually are enough to send stocks into a protracted slide. The culprit in nearly every case is recession," as Barron's columnist Ben Levisohn has written. He continued, "Markets tumble all the time, but have a way of coming back, as long as the economy continues to grow." On the other hand, he offered graphical evidence showing that all the big bear market declines since 1970, most recently the Dotcom Crash of 2000–02 and the bear market of 2007–09, were accompanied by recessions.

The 1987 stock market crash met the commonly-accepted definition of bear market, given that it was a plunge of more than 20%. However, Levisohn argues that it really was an especially sharp and severe correction, not a bear market, since stocks snapped back relatively quickly, and hit new highs within two years. Since the economy was not in recession at the time, this helps make his case for a tight linkage between recessions and bear markets, which others have made as well. (For more, see also: How do financial markets react to recessions?)

Signs of an Economic Top

An increasing number of indicators suggest that the world economy may be peaking, and that a recession may be on the horizon, Bloomberg notes. These include: monetary tightening by the Federal Reserve and other central banks; reduced borrowing by China; tariffs imposed by President Trump that are increasing trade tensions; actual economic data in leading economies that is coming short of forecasts; and measures of manufacturing confidence that seem to be topping out. Geopolitical risks also are on the rise. (For more, see also: 5 Global Risks That Could Hammer Stocks in 2018.)

As a result, economists at JPMorgan Chase & Co. (JPM) have reduced their GDP growth forecast this quarter from 3.5% to 2.5% for the euro area, Bloomberg indicates. Additionally, there are various indicators of economic slowdown in China, the world's second largest economy, from 6.9% last year to 6.5% this year, Bloomberg adds.

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