The Ultimate Leading Economic Indicator

Story Highlights:

• A number of economic reports are heightening worries of a prolonged US recession.
• These reports may or may not portend a severe US recession, but what does that mean for stock markets?
• The stock market is a powerful discounter of all known information—a reason why it's known as the ultimate leading economic indicator.
• Stock markets fall before an economic downturn and rise before economic recovery.
• The weak economic reports today are already priced into stock markets. Indeed, markets will likely turn before the economy gives indication of full recovery.

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Campaign rhetoric of late calls to mind the inescapable and much belabored phrase, "It's the economy, stupid." No wonder—presidential elections are in the homestretch just as recent polls voters are most concerned about the economic outlook. Months of financial crisis augmented by recent reports showing declining economic activity have heightened worries of a prolonged US recession.

Preliminary GDP data released last week showed the US economy contracted -0.3% from July through September versus the same period a year ago. Reports released on Monday a slowdown in manufacturing and sharp declines in auto sales for October. Wednesday will produce a report detailing October's service industry activity, and a report Friday will show October's employment data. Both the service and employment reports are expected to show contractions.

These reports may or may not portend a severe US recession (the official jury, the National Bureau of Economic Research, still hasn't proclaimed the start of a recession—but they are notorious for doing so late). But if a recession is declared, what does that mean for stock markets? Many folks assume newly announced news and the outlook they provide will move stock markets—i.e., if today's economic reports show weakness, markets will move lower today.

But we've seen instances again and again where market moves defy major headlines (in both directions). So what gives? As we've previously in MarketMinder, the stock market is a powerful discounter of all widely known information and future expectations. The ability to discount information is a reason why the market is known as the ultimate leading economic indicator. Historically, stock markets fall before an economic downturn and start to rise again before economic recovery begins.

The weak economic reports today are probably already priced into stocks. Indeed, the market will likely turn before the economy gives indication of full recovery. The economic outlook will be dour for some time as the economy continues to weigh on voters' minds well after the elections—but today's concerns will eventually fade. As will campaign rhetoric.