There is a happy signal buried beneath the surface of the stock market


It’s as close to a sure bet as markets ever offer. When the S&P 500 drops 20% or more, a recession is imminent. But economists whose gloomy calls for 2023 are informed by this signal should take a deeper look at last year’s defeat before betting on it.

Twelve months of shrinking stocks from Tesla to Amazon and from Apple to Netflix have relentlessly stormed the larger market, sending the S&P 500 into its worst year since the financial crisis. Experts brace themselves: Benchmark losses on this scale usually meant a recession was inevitable, given previous bouts of bear market signals.

But there is an alternative point of view when considering the outsized role this time played by a factor whose relevance to the economy is weak: valuation. This is a lens through which last year’s stock market histrionics can be seen as more noise than signal when it comes to the future path of the US economy.

“Investors should be careful about the economic signals they get from market action,” said Chris Harvey, head of equity strategy at Wells Fargo Securities. “We believe that much of the 2022 stock sell-off was based on the speculative bubble bursting as cost of capital normalized, not because fundamentals collapsed.”

The math is hard to refute. Fourteen times the S&P 500 has completed the 20% plunge into a bear market. In just three of those episodes, the U.S. economy failed to contract within a year.

Still, there are arguments that the most recent swoon will be an exception. Take a look at the performance of value stocks, a style dominated by economically sensitive companies such as energy and banks. After five consecutive years of outperforming their high tech counterparts, cheap stocks are finally having their moment to shine. An index-tracking value just had its best relative performance in two decades, beating growth by 20 percentage points in 2022.

As much as this bear market has sparked fears of an economic recession, it’s worth noting that nearly half of the S&P 500’s decline is attributable to the top five tech companies. And while growth companies are part of the economy, the beating of those stocks was of course mainly driven by falling valuations due to higher interest rates.

Value stocks had much less bloat to correct and so their relatively tame losses could be taken as a purer – and cheerier – signal for future activity. The last time value performed that much better was in 2000, the economy suffered only a slight downturn.

Other boards in a similar argument exist. Even the mass layoffs of companies like Inc. are hailed in some circles as something that could serve the country by moving skilled workers to other areas where there is currently a labor shortage. Meanwhile, the rising cost of capital casts doubt on the existence of unprofitable technology, potentially freeing up cash for better use.

In short, Silicon Valley, which received a huge boost during pandemic lockdowns by capitalizing on stay-at-home demand, faces a reckoning as the economy returns to normal and the Federal Reserve withdraws monetary support. However, their losses are likely gains for others.

“I’m not sure it’s a bad thing if we can do it in a non-destructive way,” Morgan Stanley strategist Mike Wilson said in an interview on Bloomberg TV earlier this month. “It is not healthy that five companies account for 25% of the market cap, as has happened over the past 10 years. We need a more democratic economy where medium and small businesses have a fighting chance.”

A new analysis from researchers at Banque de France and the University of Wisconsin-Madison shows that treating the market as a whole when assessing economic signals is less effective, in part because benchmarks like the S&P 500 can be skewed by rich priced companies or companies that derive income from abroad. The performance of industrial and value stocks acts as a better predictor of future growth, according to the study, which covers a period from 1973 to 2021.

Under that framework, the latter market route may be less alarming. The 2022 bear run was largely due to the rationalization of extreme valuations of stocks like Amazon and Meta Platforms Inc. Excluding the top five tech companies, the S&P 500’s decline would have eased from 19% to 11%. In particular, the Dow Jones Industrial Average and the Russell 1000 Value Index have held up better, both sitting within 8% of year-ago highs.

Barclays Plc strategists, including Venu Krishna, have kept a model that tracks stock leadership and business cycles and, by comparing them over time, attempts to provide a glimpse into the market’s assessment of the state of the economy. At this point, the verdict is clear: no recession.

However, according to the team, that may not be good news.

“Buyers remain confident that the economic expansion can continue,” the strategists wrote in a note last week. “This increases the risk of being sidelined, even in the event of a superficial downturn.”

–With help from Tom Keene.

More stories like this are available at