US StockMarkets Crash and GDP

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AMID last week’s stockmarket turmoil the Dow declined 5.5% on August 8th. Though a long way from being the largest one-day fall in equity markets in recent years, it was big enough to rattle investors who feared that it signalled a broad appreciation by market participants that the American economy was slowing. Talk of double-dip recessions had been muted in the months before the crash. In the days following it, investors spoke of little else.

So how predictive are big one-day falls of subsequent recession? Not very, as the chart below shows. In almost all big market falls since 1951 (when quarterly GDP figures began) the crash has come in the midst of an economic recovery. In most cases, economic growth continued for several quarters after the crash, with the notable exception of the market collapse in October 2008, which was followed by recession.

Investors have good cause to worry about the valuation of stocks in America. By measures that compare price to average earnings (Robert Schiller’s cyclically adjusted ratio) they look far from cheap. Investors also have reason to worry about the American economy, mainly because it faces considerable fiscal tightening. The one thing investors need not worry about is whether a fall in the former tells us much about the likely


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