Capital Economics concludes that while a significant retreat in equity markets would weigh on global growth, it is unlikely to be the sole force precipitating a global recession. In a note circulated Wednesday, the firm's chief global economist, Jennifer McKeown, emphasized that equity downturns tend to exacerbate existing economic problems rather than create them out of nothing.
Historical patterns and lessons
McKeown argues that history generally shows the causality runs from the economy to markets rather than the reverse - in her words, "the causality almost always runs from the economy to markets rather than the reverse." She points to past U.S. equity declines of 20 percent or more that often appear alongside recessions but seldom, if ever, serve as the initial cause of those recessions. Notable instances where market falls and economic weakness coincided include 1929 and 2008, episodes in which stock prices fell "alongside an independently weakening economy." In those cases, the downturns became more destructive as credit tightened, balance sheets deteriorated and confidence collapsed, feeding back into the real economy.
By contrast, Capital Economics highlights episodes such as 1946, 1962 and 1987 when sizable market corrections had limited economic fallout. Those periods were characterized by stable macroeconomic backdrops, healthier balance sheets, and in some cases timely policy responses, underlining the point that market corrections become dangerous primarily when they collide with pre-existing vulnerabilities like high leverage or financial stress.
Current outlook and specific risks
The firm identifies present-day vulnerabilities that could create a more perilous interaction between markets and the economy. Fiscal policy missteps or escalations in geopolitical tensions could, in Capital Economics' assessment, trigger broader economic weakness together with an equity slump. Still, McKeown cautioned against viewing a sharp market decline as the product of an "AI bubble" that would cause a recession. For an AI-driven collapse to trigger a downturn, she said there would need to be "a collapse in confidence about AI's potential," which the note regards as unlikely given anticipated productivity gains.
On near-term market expectations, Capital Economics projects the S&P 500 to fall roughly 12.5 percent next year, a drop the firm believes would have "very limited economic consequences." It adds that even a deeper 20-30 percent correction "need not cause a recession in isolation," citing ongoing steady growth, easing inflation, stronger bank balance sheets and more resilient emerging markets as supportive factors.