Could the Stock Market Decline Cause a Recession?

Since October 9, 2007, when the Dow Jones Industrial Average closed at a high of 14,164, the Dow has dropped over 11% to close at its recent low of 12,589 on January 9th. Any decline of 10% or more is known as a stock market correction.

Could the recent stock market declines help cause a recession?

Since stocks are a piece of ownership in a company, the stock market is basically a vote of confidence in the future of all these companies, and therefore the U.S. economy itself. A drop of 11% points in a quarter indicates a sustained loss of confidence.

If the confidence is not restored, and the stock market continues to fall over a sustained period of time, that would indicate the start of a bear market. This could hurt the economy more, pushing it further towards a recession. That’s because declining stock values means less consumer wealth, which drives 70% of the economy. (See "What Are the Components of GDP?"). It also means less financing for new businesses, since the sale of stocks is one way that companies can get the funds needed to grow. (See "How Do Stocks and Stock Investing Affect the U.S. Economy?"

Last, but certainly not least, a declining stock market could eventually lead to a slowdown in the global economy. That is because the U.S. economy provides 20% of the world’s output. (See "The Power of the U.S. Economy").

What should you do to protect yourself? Closely follow economic indicators over the next several weeks, especially the Advance GDP Report, released January 30th, and the Employment Report, released February 1st. Investors will be closely watching these two reports, and the stock market will react accordingly.

Otherwise, follow the financial suggestions from these About.com guides:

• Recession and Your Investments
• The Importance of Liquidity
• Before You Panic About Your Finances