Why Stock Markets Behaving Like Headless Chickens Don't Signal a Global Recession

 

Despite the stock market's recent turmoil, the global economy shows no signs of heading into a recession, with labor markets and corporate earnings remaining robust.

Is the stock market just behaving like a "headless chicken," or are there deeper reasons behind the recent turmoil? While the news headlines paint a picture of chaos and fear, a closer look reveals that a global recession is not on the horizon, offering some relief to investors. The latest jobs report in the United States has indeed raised eyebrows, with unemployment climbing from 3.4% in April 2023 to 4.3% in July. Historically, such an increase often signals a downturn in economic activity, leading to higher unemployment, bankruptcies, and lower incomes. However, this time around, the situation might be different.

In the aftermath of the COVID-19 pandemic, the labor markets across the rich world have seen some unusual trends. For instance, Germany's unemployment rate has edged up from 2.9% to 3.4%, while the UK's rate increased from 3.6% to 4.4%, and Australia saw a rise from 3.5% to 4.1%. This uptick is partly due to a relaxation of the previously tight labor market conditions. Employers, who were once desperate for workers, now have the luxury of being selective as the market stabilizes.

Moreover, the increase in unemployment rates can also be attributed to the growing number of people re-entering the workforce. The OECD's working-age labor-force participation rate recently hit an all-time high. These returning job seekers, who had previously been out of the job market, are now actively looking for work, temporarily boosting the unemployment figures. Yet, they remain optimistic about finding employment soon, as job growth remains robust. For example, employment in Australia rose by 0.8% over the past quarter, and Canada saw a 0.6% increase.

The wage growth across advanced economies further contradicts the notion of labor market weakness. In many countries, wages are growing faster than inflation, indicating strong underlying economic health. This trend is not what one would expect if a global recession were imminent.

Turning to corporate earnings, the picture looks even brighter. Deutsche Bank's research shows that global corporate earnings growth reached its highest level in seven quarters in the first quarter of this year. This strong performance seems to have continued into the second quarter, with American companies' earnings expected to grow by more than 10% year on year. Uber, for instance, reported solid results on August 6th, and many European companies are surpassing profit expectations. Even in South Korea, second-quarter earnings exceeded forecasts.

Economic activity indicators also support the view that a recession is not in the cards. The Federal Reserve Bank of Dallas's weekly tracker of American economic activity shows no signs of significant weakness. The global composite purchasing managers' index, which tracks economic conditions, remains strong, even though the rate of expansion slowed slightly in July. Goldman Sachs' current-activity indicator, which provides a glimpse of GDP trends across the rich world, is also looking stronger than most of last year.

While some economies, like Austria and France, are grappling with weak growth, their struggles have been ongoing for over a year, and the current situation is an improvement compared to a few months ago. Inflation, a major concern in recent times, is also showing signs of abating. After peaking at 10% in late 2022, inflation in the median OECD country has steadily fallen, reaching 2.6% year on year in June—close to the central banks' target of 2%. A quarter of OECD countries have already reduced inflation to this level or lower, with Italy's annual inflation under 1% and France and Germany hitting their targets.

It is somewhat ironic that recession fears are mounting just as the rich world seems poised for a "soft landing," where central banks manage to lower inflation without causing significant economic damage. Nonetheless, the fear of recession can be self-fulfilling. Plummeting stock markets may lead households to cut spending and companies to halt investments, exacerbating economic woes. Despite the current positive indicators, high interest rates continue to pose a threat, and volatile commodity prices could push inflation back up.

Without putting it in so many words, while the stock market's recent behavior might seem erratic, the global economy is not heading for a recession. The labor market remains strong, corporate earnings are robust, and inflation is under control. Investors can take solace in the fact that, despite the market's "headless chicken" act, the broader economic outlook remains positive. As for the markets themselves, perhaps they just need a good nap and a cup of coffee.