H : Would a US recession crush stocks?

– The ranks of those commentators expecting the US economy to enter another downturn have recently been swelled by the highly-respected Economic Cycle Research Institute, which has reportedly never issued a false recession forecast. So is a US contraction now a done deal?...

– A reasonable judgement is that the economy was at “stall speed” in September, reflected in a near-50 reading of the ISM manufacturing new orders index, moderately significant corporate earnings downgrades and soft labour market indicators. A further negative shock could tip it over into recession. Perhaps the financial turmoil in Europe is sufficient cause.

– A recession now, however, would be very unusual from a monetary perspective. 10 out of 11 post-war US downturns were preceded by a contraction of the real narrow money supply. The exception was the 1953-54 recession, apparently caused by severe fiscal tightening as defence spending was slashed after the Korean War.

– Monetary growth has been accelerating strongly recently, on both narrow and broad measures, with corporate liquidity particularly buoyant.The typical six-month lag suggests that the US economy will regain momentum from early 2012, if not sooner. At a minimum, ample liquidity should limit any near-term decline in spending and activity.

– Any downturn, therefore, may be mild and short-lived. This consideration is probably more significant than whether the recession-mongers are right or wrong. A modest two-quarter contraction in GDP could be met by relief by markets fearful of another “great recession”. A comparison can be drawn with 1990-91, when GDP fell by 1.4% over the winter quarters but the S&P 500 ended the recession 5% higher than when it started.