Investors have been waiting for months for high inflation readings to ease and now the ongoing bear market should provide that outcome.
That’s according to Leuthold Group’s chief investment officer, Doug Ramsey, who said in a note last week that 20% declines in the S&P 500 typically “trigger a strong, disinflationary impulse.”
That’s because the wealth effect — or the notion that consumers feel wealthier when they see their investment portfolios growing — spurs them to spend more money on goods and services and help grow the economy. The exact opposite happens when stock prices fall by a significant amount.
“The negative wealth effect certainly exists, and it’s a strong thing,” Ramsey said. The S&P 500 has lost more than $9 trillion in market value during the current bear market, while crypto markets have lost $2 trillion in value, making it hard to see that consumer sentiment and spending habits have not influenced.
Certain commodities are already showing falling prices, with lumber, copper, wheat, cotton and natural gas all finding significant bear markets, even oil prices are down about 12% over the past month.
While falling stocks would be welcomed by both investors and the Federal Reserve as it could portend fewer rate hikes going forward, Ramsey said it doesn’t mean the pain in stock markets is over. That’s because falling prices signal that the likelihood of an economic recession is even higher.
“The action that worries us most is the pullback in the CRB Raw Industrials Index because we believe it is as close as you can get to a daily version of the ISM Manufacturing Survey,” he said.
The ISM Manufacturing Index is a monthly economic indicator that measures new orders, production, employment, shipments and inventories from more than 300 manufacturing companies.
In other words, a fall in commodity prices suggests a slowdown in economic activity, which could mean that a further fall in share prices is possible if a recession hits. And while commodity prices have fallen, initial jobless claims have risen in recent weeks, suggesting the labor market could be weakening.
“If inflation was contained and the unemployment rate was still around 5%, that would be [Boom-Bust] Barometer weakness could be related to a mid-cycle slowdown. But for months we cataloged the list of economic and market developments that scream late cycle,” Ramsey said.
The unemployment rate is currently at 3.6%, so there is room for an increase before the economic scenario turns bleak. But activity is definitely starting to slow down and the US economy is already technically in recession if the Fed’s GDPNow forecast for second-quarter GDP growth proves correct.
“Overall, the bear market in equities appears to be delivering the disinflationary hit it normally delivers. Still, there is another economic event that bear markets have been good at predicting – and the evidence also points in that direction,” concluded Ramsey.