The stock market is a reliable indicator of overall economic health — except when it isn't. Back in the 1960s, the economist Paul Samuelson famously quipped that the stock market predicted nine of the last five recessions. The joke (hilarious!) is that a stock market plunge doesn't always signal a recession.
But there is plenty of reason to pay attention to stock prices as a sign of what's to come. George Morgan, a professor of finance at Virginia Tech's Pamplin College of Business, explains that the stock market gives a snapshot of the economy six months down the road.
"A sustained drop in equity values is a leading indicator of the lower profits expected to be earned by corporations," Morgan says, "or at least lower profits than the stock market had previously expected."
If businesses lower their expectations for the future, that means they'll be taking out fewer loans and hiring fewer people, which impacts the broader economy. And when stock prices across the board go down significantly, it starts to eat away at the long-term savings of average consumers, causing spending to drop.
When CNBC analyzed post-War stock market performance for hints of upcoming recessions, it found a strong correlation. The longer a bear market lasts (defined as a drop of 20 percent or more in stock prices), the greater the odds of it signaling a recession. Bear markets that cause recessions lasted 508 days on average.