Or simply frontrunning central bank policy, economists would use it to anticipate key economic inflection points such as recessions and recoveries.
Which is also why the recent correction in the market has spooked all those conventional economists who still believe there is a “market” instead of a centrally-planned “wealth effect” policy tool, whose only purposes is to react to every increase in the global $14 trillion central bank balance sheet.
It is these economists, which also include the academics on the Fed’s staff, who took one look at the tumble in stocks in the past two weeks and decided that a rate hike may not be such a hot idea after all.
Because if the market is sliding, it surely is telegraphing that not all is well with the economy and therefore tightening financial conditions would be suicidal for any central bank.
So assuming that after being wrong for 7 years about everything, economists are actually right about the market still having some discounting abilities left, what then is the market telegraphing?
The answer, according to the Bank of America: the biggest surge in recessionary odds since 2011, which over the past few days have nearly hit a 50% probability of an economic slowdown.
Recession probability from stock prices shoots higher: The more interesting and difficult question is whether the equity correction is signaling a deeper economic malaise. Equity prices can be leading indicators of recession. Indeed, Michael Hanson has developed a variety of probit models that use financial variables to estimate the risk of a recession.
According to his model, the 15% annualized drop in the S&P500 index (over the past six months) is signaling a 47% risk of recession starting sometime in the next 12 months. That sounds fairly grim; however, we wouldn’t take the signal too literally. As Paul Samuelson famously quipped in the late 1960s: “The stock market has called nine of the last five recessions.”
Our probit model sends a lot of false signals. For example, in 2011 the model saw a 59% chance of recession (which we argued strongly against at the time).
Here is the chart that BofA has created to track coincident recession odds based on market signals:
Actually BofA is dead wrong about 2011 being a false positive: the only thing that delayed the 2011 recession, was the Fed’s launch of Operation Twist in September of that year, coupled with the Fed’s liquidity swap line bailout of Europe in November, and the commencement of the ECB’s massive €1 trillion LTRO in December 2011.
It was this liquidity avalanche that delayed the effects of what was a guaranteed recession, one which even the ECRI called.
Delayed but not eliminated, and with every passing year that the world’s central banks have kicked the can of the global business cycle’s down phase, the more acute it will be when it finally launches.
Finally, unlike 2011 this time not only is the Fed not planning any pro-cyclical liquidity interventions, but Yellen is actively considering tightening monetary conditions as soon as September with the start of the first rate hiking cycle in nearly a decade.
Which is why while the market may or may not be correctly discounting a recession this time, or anything else for that matter, an economic recession is precisely what is coming, just because every single time when financial conditions were as adverse as they are now, the Fed would proceed to bailout if not the economy, then certainly the “market.”
This article is brought to you courtesy of Tyler Durden From Zero Hedge.