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Is a recession coming? Making sense of Wall Street's wild signals

Gary Cohn on US economy, government shutdown

Fears of a U.S. recession have been mounting with Wall Street appearing to be headed for its worst December since 1931 -- yes, during the Great Depression.

The stock market's sustained slump since October has been fueled by investor concerns about lower corporate profits, higher corporate debt, a festering trade war between the U.S. and China and a broader global slowdown.

So is a U.S. recession imminent? Not necessarily.

Plenty of economic gauges suggest that far from being derailed by a stock market that's set to suffer its first annual loss in a decade, the $20 trillion U.S. economy is barreling forward. Employers are hiring, consumers are spending ahead of the holidays and economic growth has been brisk, thanks in part to President Donald Trump's deficit-financed tax cuts.

But America's economy has been growing since mid-2009 and nothing -- not even what has become the second-longest U.S. expansion on record -- lasts forever. As this recovery has aged, economists and business leaders are increasingly predicting it will end within the next two years.

IMF chief sees "no signs" of U.S. recession "in the near term"

The fact is that recessions are a regular part of the economic cycle. A downturn won't necessarily happen in 2019. But the recent free-fall in stock prices in the U.S. -- as well as China and Europe -- could hasten the day.

"While we aren't explicitly forecasting a recession next year, we wouldn't rule out a mild one," said John Higgins, chief markets economist of Capital Economics. "At the least, we expect a significant economic slowdown."

Analysts at Oxford Economics are similarly of two minds. "The deepening rout in the financial markets heightens the downside risks to the economic outlook," it said in a recent note. "Our base case is that the investor pessimism is overdone and decoupled from solid albeit moderating economic fundamentals. However, we recognize the rising risks to economic growth from a negative markets feedback loop."

It added that it doesn't believe that loop has been activated yet, "supporting our call for a gradual rather than abrupt economic slowdown in 2019."

Overall, nearly half the chief financial officers surveyed by Duke University foresee a recession by the end of next year. And by the end of 2020, 82 percent do so.

Here's a look at how stock market movements and economic barometers might determine the risks of a recession.

Does a sustained stock price drop herald a recession?

Sometimes. Not always. The past two U.S. recessions both overlapped with stock market sell-offs. The Dow Jones industrial average plunged nearly 32 percent in 2008 after the housing bubble burst. And it shed more than 5 percent in 2001 when the tech stock bubble burst. But stocks also declined in 2002 -- a year when the U.S. economy expanded.

The fact is that the stock market captures just a piece of the broader U.S. economy. Less than half of U.S. households even own any stock, according to New York University economist Edward Wolff. And more than 80 percent of the stock market's value is controlled by the richest 10 percent of households, according to his calculations.

The bulk of most Americans' net worth is derived from a different asset: Their homes.

Uncertainty behind sharp declines in stock market

How bad is the stock market decline?

It's painful. But Wall Street has endured far worse sell-offs. 

Year-to-date, the Dow has lost about 5 percent -- just a small fraction of its 2008 plunge. And the recent losses follow an extraordinary winning streak: From its bottom in March 2009, the Dow has rocketed 250 percent. This means investors who have held on have earned a rich profit -- even including the losses since October.

That said, the past two months' decline has been severe -- about 12 percent. That puts the market into "correction" territory, commonly defined as a drop of at least 10 percent.

What's behind the economy's strength?

Look to the job market. The 3.7 percent unemployment rate is near a half-century low. Average hourly wages have climbed 3.1 percent in the past 12 months, the strongest such increase since 2009.

The solid employment picture has helped fuel consumer spending. Retail sales have grown 5.3 percent so far this year as more Americans are eating out and shopping online, according to the Census Bureau.

The jobs market is also where to watch for signs of a recession. Ahead of the 2008 financial crisis, the monthly hiring levels swung from gains to losses and unemployment shot up. The Labor Department issues a weekly report on people applying for unemployment benefits. A sustained increase in such applications would signal that employers are shedding workers in anticipation of a downturn.

Does the housing market point to recession?

This is tricky. By some measures, like the Census Bureau's report on home construction, the real estate market never really recovered from the meltdown of a decade ago. As a result, housing has contributed relatively little to the economic recovery, which makes it less likely to be a major force that tips it into a recession.

What has generally recovered are average home prices, steadily rising faster than Americans' average wages for the past few years, according to the National Association of Realtors. This made some homeowners wealthier. But it also reduced affordability of homes for many would-be buyers.

Until this past year, homebuyers had been helped by historically low mortgage rates. But those rates began to creep up last year as it became clear that Mr. Trump's tax cuts would swell the federal budget deficit by more than $1 trillion in coming years. Mortgage rates generally move in sync with 10-year Treasury notes. As the average 30-year mortgage rate has risen to 4.63 percent from 3.93 percent a year ago, home sales have fallen.

Trump: Federal Reserve thinks "our economy's too good"

Are the Fed's rate hikes a risk for recession?

The Federal Reserve has become a punching bag for Mr. Trump as the stock market has tumbled. The Fed is widely expected to raise its key short-term rate for the fourth time this year on Wednesday, which would likely further raise borrowing costs for consumers and businesses over time.

The Fed is lifting rates to try to keep inflation at its 2 percent annual target while maximizing employment. But if it miscalculates and raises rates too high or too fast, history suggests it could trigger a recession.

Compounding the risk is that the Fed is also reducing the huge bond purchases on its books, which resulted from the trillions in Treasury and mortgage bonds it bought to help the financial system recover from the 2008 financial crisis. Doing so magnifies the upward pressure on borrowing rates for consumers and businesses.

Could resolving a trade war with China head off a recession?

President Trump caused stocks to buckle when he ratcheted up taxes on Chinese imports in hopes of forcing Beijing to strike a deal that would protect U.S. technology from theft and reduce the U.S. trade deficit with China. Stocks recovered somewhat when further tariff increases were suspended after Mr. Trump met with Chinese President Xi Jinping earlier this month at an international gathering in Argentina.

A prolonged trade war could surely depress growth. But it's unclear whether any new deal would speed growth to the point where a recession could be avoided.

The fact is that economic growth around the world is slowing, including in the U.S. as the benefits from the tax cuts wane. Britain is struggling to leave the European Union. France faces economic unrest. Italy appears to be in recession. China is trying to engineer slower growth after a multidecade boom that would be destabilizing if it had maintained its once-sizzling pace.

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