The stock market played a dangerous game on the economy in December.
You’ve heard of self-fulfilling prophecies, right?
The idea is that making a prediction helps the prediction itself come true.
Even though the stock market was on a roller coaster throughout 2018, the 15% plunge on the S&P 500 Index in December stood out.
While the volatility was a novel way to cap off a tumultuous 2018, it may have lasting impacts.
Worries over the Federal Reserve interest rate policy and a slowdown in China sparked the rapid sell-off.
At the time, there was no sign of weakness in the U.S.
That changed last week.
Retailers announced a 1.2% drop in sales for December. It was a complete shock.
It is the worst decline since 2009.
This tells us that the stock market plunge in December did more than spook investors.
It spooked consumers.
The material impact on the economy could have a lasting effect. Here’s why…
Economic Growth Is Tied to Consumers
The fall in retail sales had an immediate impact on a key measure of growth, the gross domestic product (GDP).
The GDP measures growth in the U.S. economy.
The dip in sales created a sharp drop in GDP growth estimates for the fourth quarter. This showed that the consumer is a key driver of economic growth.
And a sign of weakness in retail sales tells us that the consumer isn’t as strong as we believed.
This could set the stage for a recession as early as this year.
As soon as I got the email about the impact, I tweeted out the following chart.
Weak retail sales hurt #GDP expectations this morning. This @AtlantaFed chart shows GDP is down to 1.5% for the 4th quarter. The shutdown likely added to economic weakness. We’ll see if December 24 lows are tested. pic.twitter.com/kOx3OWwrFo
— Chad Shoop, CMT (@ChadShoopGuru) February 14, 2019
My tweet mentioned that the stock market could test the Christmas Eve lows based on proof of weakness in the economy.
GDP expectations plunged on the report.
They fell from a modest 2.6% growth rate to only 1.5%. That’s more than one percentage point lower.
Since it was the biggest drop in retail sales since 2009, it was also the sharpest decline in GDP expectations.
Two quarters of negative GDP growth commonly define a recession.
While the fourth quarter of 2018 isn’t expected to turn negative, the sharp drop is alarming.
Any more weakness and we are on a path toward a recession this year.
This is all tied to the stock market’s effect on the consumer.
2 Negative Quarters Mean a Recession
The December stock market plunge was alarming, not because of the magnitude of the decline, but because of the impact it had on consumer spending.
Investors became concerned about the economy. Their concern pushed the market down, and that had a direct impact on consumer spending.
December is typically a strong spending month. Consumers rush to get last-minute holiday gifts throughout the month.
The concern now is that this weakness began as we were heading into the weaker spending months of January and February.
Knowing that the year ended on a weak note means we likely won’t see a bounce back in the first quarter.
It is a seasonally weak quarter to begin with, as cold weather reduces economic growth.
But the historic government shutdown and ongoing uncertainty with China’s trade talks mean the quarter could have negative economic growth.
Will we see two quarters of negative growth to get an official recession?
It’s too early to tell, but it will be almost certain if the stock market crashes again.
We can expect volatility to remain throughout 2019. While it is stomach-churning for long-term buy-and-hold investors, it’s exciting for short-term traders.
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Chad Shoop, CMT
Editor, Automatic Profits Alert