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recession: Vinod Nair decodes impact of recession on stock markets

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recession: Vinod Nair decodes impact of recession on stock markets


The US economy contracted for the second consecutive quarter amid aggressive monetary policy tightening by the nation’s central bank, which has been trying hard to bring down the decades-high inflation. As the GDP figures became public, the experts stated that the US is already in a recession, while critiquing the central bank (Fed) for being in recession denial mode. So, what is recession?

Recession is defined as the period when the economic activities, ie, demand and supply breakdown below the normal level of momentum in the economy. Gross domestic products (GDP) is used as a key indicator to assess the rate of growth of an economy. Quarterly data of real GDP growth provides a decent indication of the ongoing economy.

While there is no universal consensus on the exact definition for recession, economists and fiscal experts usually see the negative GDP growth for two consecutive quarters as a statistic for a technical recession. Because it is possible that the GDP is slowing due to varied short-term factors without affecting the broad economy with a sustained employment market.

Many other leading high-frequency (monthly) indicators like Purchasing Managers Index (PMI), Index of Industrial Production (IIP), Consumer Sentiment, Housing prices, Oil Prices, Bond Yields etc., are also used to predict the future trend of economic growth. These month-over-month data improves the throughput to forecast future economic activity but with the notion of MoM volatility, like for an emerging country like India, however effective for a developed nation like the US.

Today, the world is concerned about recession because of hyperinflation and geopolitical issues. Inflation is elevated due to supply constraints stipulated by Covid-19, war, and easy money policy of 2020-22. It is estimated that prices will continue to be on the higher side due to economic imbalances. And the late repair of the monetary policy from easy to super hawkish plan leading to extremely rise in interest rates. Both these factors are expected to slow down the world economy and lead to a recession.

Technically, the US, the leading economy, is already under recession. Q1CY22 Real GDP QoQ growth was down by -1.6% followed by -0.9% in Q2. This is expected to continue in Q3 will a consensus of -0.6% to -1 %. Similar slowdown is seen in other key economies like China with -2.6% fall in Q2 and for Euro region weak data is estimated in Q3 & Q4 due to uncontrollable power prices. Many countries are under stress like Sri-Lanka, Russia, Ukraine , Canada, New-Zealand, East-Asia & Africa. Undoubtedly, the economy is on a fix. IMF has consistency downgraded the outlook of world economy in 2022. In the latest update, stated the scenario as ‘gloomy & more uncertain’ cutting the GDP forecast to 3.2% & 2.9% for 2022 & 2023, respectively, below the average pre-covid growth of 3.74% in the last decade.

Certainly, the effect of recession on the stock market is bearish. Market usually reacts in advance of the actual fall of the economy. Quantitative & Qualitative factors like geo-political issue, level of valuation, range & spread of bond yield (long-term minus short-term yield), optimism & sentiment of market, inflation leads the market trend.

In the last 2months, the world’s stock markets has strongly reverted positively, after the heavily fall of H1CY22. The sustenance of the rally will depend on the ability to control inflation without impacting the consumer sentiment. This is going to a challenge as disposable income is under the double whammy of rising inflation & interest rates. Till date, it has not impacted the job market. For reference, though GDP growth in the US is negative unemployment rate is exceptionally low at 3.5% much below the historical average of 5.8%. The job market added a whopping 530,000 jobs in July and, more hearteningly still, consumer prices did not rise compared with the month earlier. The market is sticking with the view that inflation will rapidly fall, indicated by falling metal prices, not requiring sharp rate hikes in the future. For that market may need some time to honor while valuations are back to high range.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)

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