As markets continued their wild ride today, clawing back most of their losses from Monday, including a nearly 600 point drop on the Dow, it’s important for us to take stock of where we are.
And we are not in a situation that resembles the start of the last financial crisis. By in large we are in a recovery, and the health of businesses is pretty strong. You can expect the events unfolding in China to act as a drag on our own economy, but events there probably won’t tip us over into recession.
Here’s why: The stock market is not the economy. And as opposed to the recent financial crisis, which was driven by bad consumer mortgage debt and other unsustainable leverage, businesses today are sitting on stronger sales and revenue, healthier balance sheets, and greater access to capital.
Numerous small business surveys from the past year back this up. Consider U.S. Bank’s annual survey from the spring, which shows that more than three quarters of the nation’s small businesses rate their businesses as financially strong. More than half say their revenues have been stable year over year, up 10 full percentage points since 2014. And 65 percent say it’s now easy to borrow money to fund operations, an increase of 20 percentage points compared to 2014.
And for anyone concerned about debt, the percentage of businesses using earnings to finance their operations, as opposed to loans, has also held stable over the past year at 35 percent, according to the National Small Business Association’s year-end report on the state of small business for 2014.
As the New York Times pointed out on Tuesday, there have been seven events since the economic crisis of 2009 where the S&P 500 has fallen five percent in the course of a week. Some of those drops have been the result of self-inflicted wounds, like the Congressional failure to raise the debt limit in 2011, which resulted in a downgrading of U.S. credit. Excluding the most recent drop, the others were all followed by recovering stock prices.
This week's stock market plunge is potentially more serious than these other events, as stocks are now down 12 percent compared to the market high reached in May. However, we are only in correction territory, rather than a bear market. And the Dow is still up 60 percent compared to the same time period in 2013. So take a breath.
Long bear markets, defined as a drop of 20 percent or more in stock prices over the course of months, do tend to correlate with recessions. So far we have experienced a correction, defined as market drop of 10 percent from a previous high.
In fact, mutual fund company Hussman Funds, which analyzed events that precipitated the financial crisis, which began in 2007, in this blog post, notes that bear markets that induce recessions are usually twice as long as those that don’t produce recessions. And those bear markets typically last more than a year.
So get back to work. We still have a long way to go before we need to worry.