Predicting an economic recession is difficult enough, even with tons of economic data. For example, we learned this week that GDP grew at a 4.2% annualized rate during the second quarter (Q2). This is very strong growth, indeed. Consumer confidence is at a 17-year high. Not surprisingly, Consumer Spending is robust. The economic data tells us there is no recession on the immediate horizon.
Predicting a stock market correction or crash is much more difficult. It is more art than science. While there is a flood of corporate data to analyze, the stock market is more forward-looking than corporate data or economic data, which are backward-looking. In addition, stock market behavior has a strong emotional factor. Over-reacting to news is a constant of the stock market.
Predicting a financial crisis is just plain hard. One reason is that a financial crisis occurs suddenly. There is also less data on the financial system to analyze. The required data that is released usually reflects the last financial crisis, but “we don’t know what we don’t know.” Some data is unknown and unreleased. A financial crisis usually begins with a “Minsky-moment” – when debt keeps expanding and expanding like a balloon, until it bursts. Unfortunately, debt has many different names and accounting treatments are not the same.
The differences are important. It is common for investors to ask about economic recessions, when they are really just worried about a stock market crash. Both are routine in a capitalistic economy. However, when they begin with a financial crisis, both economic recessions and stock market corrections are made much worse.