An exceptionally robust job market. The Federal Reserve raising interest rates at a rapid clip. Overheated financial markets starting to correct themselves, with the frothiest sectors bearing the brunt.
That's the situation today — and was also the situation in the spring of 2000, when the dot-com bubble started to burst. A recession followed, but not until a year later.
Why it matters: The year 2000 offers important lessons for the nature of the risks the economy is facing — and what to watch to understand just how bumpy the ride from here could be.
Flashback: The stock market peaked in March 2000. But as the year progressed, the signs mounted that the good times were nearing an end for money-burning internet companies.
- The layoffs started as a trickle and became a gush. IPOs were shelved, and the companies that had gone public saw their share prices dwindle. Websites popped up to track the burn rate and layoff plans of "F*d" companies.
Yes, but: The overall economy actually held up great through that year. The vast majority of people, after all, did not work for dot-com firms, and corporate America as a whole was still fundamentally bullish on investment and hiring.
- The number of people filing new jobless claims reached a multi-decade low in April 2000 and didn't begin rising seriously until the tail end of the year. The unemployment rate finished the year at 3.9%, only one-tenth above its April low.
- Inflation reached its highest level in a decade of 3.8% that March, and the Fed raised interest rates a half-percent in May to try to rein in inflation.
It was only in 2001 that the wheels started to come off the broader economy, as companies curtailed growth plans and layoffs became more widespread. Economists would eventually date the beginning of a recession to March 2001 — a full year after the stock market peak.
- What's more, it was an unusually mild recession — and may not have been counted as a recession at all if the September 11, 2001 terrorist attacks hadn't happened. The attacks sent an already shaky economy into a temporary tailspin — a reminder that geopolitical events can cause more economic pain when the situation is already precarious.
The big picture: If you take the parallels between then and now seriously, it has some important implications for how the economy will fare in the coming months — and what to watch to know if an all-out recession is taking place.
- Watch carefully whether corporate behavior starts to change outside the companies most directly affected by the stock market selloff and crypto collapse. It doesn't matter much for the overall economy if Robinhood or Coinbase lay people off — but it's a different story if the full gamut of companies start doing the same, or cutting capital spending plans.
- Consumer demand propelled the economy forward and was the reason the recession was so mild in 2001; there was not a single quarter that year in which personal consumption spending declined. That looks likely to be true in this episode as well, given strong household balance sheets and rising wages.
- Pay more attention to corporate debt markets than the stock market. The real economic problems of 2001 came as losses in the telecom sector caused a wave of bankruptcies and led investors to sell off all types of corporate bonds — tightening the flow of credit in the economy, a key feature of the 2001 recession.
One more thing: Be ready for the recriminations. The receding economic tide two decades ago exposed deep rot at companies far from the dot-com boom, like energy trading firm Enron and industrial company Tyco International.
The bottom line: The U.S. may well escape a recession this time around. But when the market sentiment reverses, like it did 22 years ago and is doing now, it becomes more vulnerable to whatever bad news may arrive.
