The current state of the stock market seems oblivious to the potential of an impending recession. Despite signs of an economic slowdown, history reveals that market gains may persist.
Market Performance vs Economic Activity
As we observe the S&P 500’s impressive 17% surge this year, reaching about 4500, the ISM Composite Purchasing Managers Index (PMI) paints a contrasting picture. In the first half of this year, the PMI experienced a slight decline of approximately 1% compared to the same period last year. Though there has been a recent uptick of about 1%, it remains relatively modest.
The Cooling Effect of Higher Interest Rates
To combat economic demand and inflation, the Federal Reserve has implemented higher interest rates, which are beginning to have a cooling effect on the economy.
Market and PMI Data: Typically Aligned
Usually, market performance and PMI data tend to move in sync, according to experts at Morgan Stanley. If this were the case currently, the S&P 500 would be hovering around 4000—a significant 12% lower than its current level.
Breaking Historical Trends
Nevertheless, historical data demonstrates periods in which the market has detached from economic indicators. For instance, from late 2015 through much of 2016, the S&P 500 recorded a 5% gain while the PMI lagged behind its previous year’s level. Additionally, from mid-2016 to the pre-pandemic peak in early 2020, the S&P 500 outperformed with remarkable growth of over 60%. Surprisingly, during that time, the PMI remained above 50, indicating expansion mode for the majority of the period.
In summary, while upcoming economic challenges might suggest a different outcome, the stock market has defied expectations in the past. Only time will reveal whether the current trend will persist or align more closely with economic data.
Economic Growth and Market Outlook
In the first half of 2017, the S&P 500 experienced gains while the PMI slipped, resulting in a subsequent rise of the stock index. This increase amounted to an impressive 39%, pushing it back to pre-Covid levels.
Despite brief periods of economic weakness, the market consistently ignored these downturns and focused on the overall growth of the economy. From 2016 to 2020, the real gross domestic product experienced incremental growth, albeit in low single digits. It was not until lockdowns were implemented, causing a global economic shutdown, that a recession was finally triggered.
Interestingly, we are currently witnessing a similar dynamic. The market perceives that a recession induced by the Federal Reserve has not yet occurred. While there is a possibility of a mild recession, it is highly likely that the Fed would adjust interest rates before this happens. As inflation rates decline, the Fed would halt rate hikes, subsequently allowing the economy to stabilize and grow.
Analysts have also identified several factors that contribute to this positive outlook. Firstly, demand is expected to increase next year for industries related to housing and consumer electronics – two sectors that faced setbacks in 2023. Additionally, the travel and leisure industry is predicted to experience a resurgence in demand.
These reasons provide clarity behind the market’s recent gains, demonstrating that they are not a mystery. Moreover, they suggest that this upward trajectory can be sustained.