As the US stock market heads into what looks to be its worst month in more than five years, the big question for the average person's life is this: Are we watching a replay of 2008 or a replay of 1987? If it's the former, you should freak out. If it's the latter, you just need to hold tight.
It could be really bad, or it could be not so bad. But here's what we do know: The price of stocks declining is unlikely to be the cause of bad things in your life. If it's bad news, it's bad news simply because stock markets offer a fast and highly visible window into economic conditions.
- If massive layoffs and a general collapse in business conditions are in the works, then the exact same things that cause those are likely to cause a stock market decline.
- But then again, history also shows us that sometimes there are sudden moves in financial markets that don't signify anything at all.
In 2008, falling stocks were a sign of a tumbling economy
It's unlikely that anybody lost their job during the Great Recession because the price of stocks fell. Some people probably lost jobs because of the falling price of commodities (food, oil, metal, and other raw materials), because lower prices mean less incentive to produce more. But then again, falling commodity prices are good for most people and sometimes provide the economy with a boost.
Nonetheless, the large decline in stock prices that happened in the fall of 2008 was bad news for the vast majority of Americans.
That's because the crash was, in effect, a warning sign that was ignored. Financial markets were signaling an expectation that the outlook for business profits was getting much worse. Commodity prices were signaling an expectation that overall levels of demand would plunge. These dire predictions proved to be 100 percent accurate. It takes weeks and even months for all the relevant data about the performance of the real economy to pile up. But stock markets can move really quickly. Bad things were happening.
In 1987, markets plunged and then ... nothing happened
Twenty years earlier, though, a similarly dramatic collapse in stock prices had a very different result. Here's how it looked in the heat of the market panic:
But there was no late-Reagan-era recession. No global economic catastrophe. Instead, it looks in retrospect like investors just panicked for no good reason. Or maybe that they had good reason, but then Alan Greenspan moved swiftly to nip it in the bud. Either way, the downturn actually lasted quite a while even though nothing special was happening in the real economy.
Eventually, stocks went back up. After all, nothing bad was going on, so why shouldn't they have?
Bottom line: Be concerned, but not too concerned
The August stock slide is a clear sign that investors are worried about corporate America's performance outlook, and since plenty of people work for big American companies, that's reason to be concerned. But not too concerned.
There's no particular reason that cheaper stock prices should cause anything bad to happen to the vast majority of people. A sharp decline in house prices has a huge impact on the real economy because middle-class Americans have so much of their net wealth tied up in houses they bought with borrowed money. The stock market isn't like that. Shares are mostly owned by rich people, and middle-class Americans don't borrow money to buy stocks.
Similarly, though the weak Chinese economy is definitely bad news for Apple and a handful of other American companies with lots of Chinese customers, US exports to China are not that big of a deal overall. Meanwhile, the falling price of oil helps the US trade balance and puts money into the pockets of most people.
So there's a great chance that everything will be fine. But policymakers at the Federal Reserve — and, were it actually a functioning policymaking body, the US Congress — ought to be vigilant. US stocks in decline could be an early sign of some more profound weakness. On Thursday, the Commerce Department will report on second-quarter GDP, and on Friday it will tell us about personal income in July. We'll also get data this week about initial unemployment claims. A stock market decline doesn't necessarily mean anything terrible for the real economy, but it is important context with which to read those reports when they're out.