There's an Upbeat Signal Buried Beneath the Stock Market's Surface

It’s as close to a sure-thing bet as markets ever offer. When the S&P 500 falls 20% or more, a recession is close behind. But economists whose dour calls for 2023 are being informed by this signal should look deeper into last year’s rout before betting the farm on it.

Twelve months of drubbing in stocks from Tesla to Amazon, Apple to Netflix have pounded the larger market relentlessly, sending the S&P 500 to its worst year since the financial crisis. Pundits are braced: Benchmark losses on this scale have usually meant a recession is inescapable, going by past bouts of bear-market signaling.

But an alternative view exists when considering the outsize role played this time by a factor whose relevance to the economy is tenuous: valuation. This is a lens through which last year’s stock market histrionics can be viewed as more noise than signal when it comes to the future path of the American economy.

“Investors need to be careful about the economic signals they divine from market action,” said Chris Harvey, head of equity strategy at Wells Fargo Securities. “We believe much of the 2022 equity selloff was based upon a popping of the speculative bubble as the cost of capital normalized, not because the fundamentals collapsed.”

The math is tough to rebut. Fourteen times the S&P 500 has completed the 20% plunge into a bear market. In just three of those episodes did the American economy not shrink within a year.