Why Are Markets Acting like Recession Is Looming?

Data shows a solid economy, yet markets are acting like recession is around the corner. Russ explains why.

An investor who ignored economic releases and instead focused on equity and bond markets might be led to believe the economy is shaky, on the cusp of sick. Even aside from the well-publicized flattening of the yield curve, investor behavior looks particularly cautious. During the past three months, U.S. Treasury and German bond yields have fallen approximately 30 basis points (bps, or 0.30%), industrial metal prices have collapsed and defensive sectors, such as healthcare and consumer staples, have trounced their more cyclical cousins, notably energy and materials.

Yet U.S economic activity looks solid, bordering on strong. Second quarter gross domestic product (GDP) growth was the fastest since late 2014, household consumption is surging and industrial production is recovering from the manufacturing recession of 2015-2016. Looking at more forward looking measures, business confidence is high and the residual impact of tax cuts and fiscal stimulus should produce a strong second half.

So why are investors behaving as if the economy is slipping towards the abyss?

1. Weakness outside of the United States.

Everyone is painfully aware of the travails in Turkey and Argentina. The truth is that in addition to a few vulnerable emerging markets, there are other pockets of weakness, albeit less severe. Europe and China are decelerating. Global growth (G-8) estimates peaked in March and have been slipping ever since.

2. Reality has not met expectations.

As strong as the economy is, even in the United States economic releases have not quite kept up with overly aggressive forecasts. Economic surprise indexes, which measure reported economic data relative to expectations, are now falling in the United States and are negative in much of the rest of the world (see Chart 1).

econ surprisesFinalindexes