On Tuesday night, President Obama proclaimed that the state of economy was strong, mostly based on job growth—14 million since the end of the Great Recession.
The market, though, is telling a different story. On Friday, the Dow Jones Industrial Average was down nearly 400 points. That capped off the worst two-week market start of a year since records have been kept, which for the Dow Jones Industrial Average goes back to 1897. Even with the rebound on Thursday, the S&P 500 is down a little over 8% for the year, and off about 11% from its high last May.
Of course, the economy and stock market don’t always go hand in hand. What’s more, the market’s troubles are not all on account of the state of the U.S. economy. Many of the factors are out of President Obama’s control. The stock market has fallen on the fact that the global economy, particularly China, looks like it is weakening. Economists have cut their expectations for worldwide growth to 3.3%. Bond market guru Jeffrey Gundlach of Doubleline has said growth could be as low as 1.9%, making 2016 the worst year for the global economy since 2009.
The U.S. economy remains one of the most stable in the world. But more and more market watchers are starting to say that the drop in the market may suggest that America’s economy, despite its low 5% unemployment rate, may be worse off than many think. On Friday, the typically bullish Citigroup strategist Tobias Levkovich cut both his profit estimate and forecast for the the S&P 500.
“A lot of smart people are changing the way they are looking at the market,” says Michael Antonelli, head of stock trading at Robert Baird.
When the market enters a correction, as it did on Wednesday, it often signifies that there are problems in the economy. And those challenges are not just confined to what’s happening abroad.
Perhaps the biggest factor hurting the stock market is corporate profits. For the first time since the Great Recession, the bottom line for companies in the S&P 500 are estimated on average to have fallen 0.7% between 2014 and 2015. For the fourth quarter of 2015, earnings are expected to be down an even bigger 5.3%. The biggest drag comes from the oil sector, but even if you exclude oil companies, profits at the remaining S&P 500 companies were flat from a year ago.
Growth has been lackluster in part because American consumers still seem reluctant to spend. The drop in oil prices was supposed to be a big boost to the U.S. economy. Lower gas prices would put more money in consumers’ pockets that they could run out and spend. That has happened, but not as much as economists expected. Consumption increased in 2015, but it was uneven. After growing over 1% earlier in the year, spending growth slumped to just 0.3% by the end of the year. This week, the National Retail Federation said that holiday sales rose 3% last year, which was lower than expected.
You can chalk the disappointing spending up to flat wage growth. Median average wages grew by just 7% over the past seven years, one of the weakest rates for an economic recovery. This suggests the labor market is weaker than the 5% unemployment rate would suggest.
For one, the labor force participation rate is the lowest it has been in decades. This is likely the result of more and more baby boomers retiring. But the participation rate has also fallen among workers 25-54 year old, suggesting at least some of the drop has to do with frustrated workers who have given up on the job search.
Falling long-term interest rates mean that investors think the economy is likely to slow. And that’s what’s happening right now. The yield on the 10-year bond dropped to 2.04% on Friday from 2.11% about a month ago, when the Federal Reserve raised interest rates.
None of this means we are headed for a recession. But narrative leading into the new year was that low unemployment and low gas prices would mean smooth sailing for the U.S. economy in 2016. The persistent drop in the market may suggest it is time to reconsider that story.
