Double-dip recession: Could it be a 'sell-fulfilling' prophecy?

A nosedive in stock prices doesn't mean a double-dip recession is inevitable. But investor sell-off could hurt an already weak economy by dampening consumer and business spirits.

Financial markets took another rough ride Wednesday, amplifying concerns that the US economy could be embarking on a "double dip" back into recession.

Policy signals from the Federal Reserve had helped to ease investor fears a day earlier. But by late Wednesday, the Dow Jones Industrial Average was down over 350 points for the day, moving below the 11,000 level.

Although several factors have set investors on edge, the most basic is concern about whether the economy will grow or veer into another recession. The answer will have big implications for American jobs and incomes, as well as corporate share prices.

So is a double dip arriving?

It's very hard to tell, especially considering the tepid pace of recent economic growth. Forecasters have a far-from-perfect track record in seeing turning points, and distinguishing a temporary slowdown from a slide into recession.

What's clear, though, is that forecasters see a higher risk of recession than they did just a couple of months ago. Many say the risk is substantial – a 25 to 50 percent chance.

And if stock prices fall further, that itself could increase the likelihood of a double dip. Weak stock prices make it harder for companies to finance new ventures, and sagging account balances can dampen consumer confidence. In that sense, what might be called a "sell-fulfilling" prophecy is possible, in which investors, selling in fear of an economic slowdown, help make one happen.

Growth in gross domestic product has cooled markedly so far this year. America was posting GDP growth near a 4 percent annual rate at the start of 2010. That dwindled to barely 2 percent by year end, and just 0.4 percent and 1.3 percent in the first two quarters of 2011.

"Every time real GDP growth has decelerated to less than 2 percent on a year-to-year basis the economy has either already been in recession or fallen into one within a year," economist Mark Vitner of Wells Fargo wrote in a recent analysis, citing 11 instances since 1950. "The record is not very comforting."

In the most recent quarter, GDP is up just 1.6 percent from the same period a year before, according to Commerce Department numbers.

That doesn't mean a new recession is inevitable. It could just be an indicator of how difficult the current recovery is, due to the overhang of high consumer debts and government debts. In 2002, the pace of GDP growth was weak in the aftermath of a recession, but a double dip didn't occur.

But the recent slow pace of GDP leaves the economy vulnerable to any unexpected shock, such as a possible turmoil over European government finances.

Mr. Vitner and his colleagues at Wells Fargo see a 1-in-3 chance of recession in the near term, essentially this year or next.

Here are some of the current economic indicators to watch:

• An index of so-called leading indicators, designed to forecast the economy, stands well above levels that normally signal recession. The index, which includes stock prices as one component, rose in July.
  
• Oil prices have fallen amid the market mayhem of recent days. If the price drops persist, that essentially acts like a tax cut for consumers. They'll have more money to spend on other things, which could offset the damage from lower stock prices.
  
• Consumer incomes and spending have been rising during the two years since the official end of the 2007-2009 recession. However, consumer spending was flat in the second quarter.
  
• The so-called "yield curve," the spread between short- and long-term interest rates, has shifted in a negative way.

Often before a recession, the yield curve "inverts," with short-term borrowing costs higher than longer-term rates – a result of investors spotting trouble before the central bank, which sets short-term rates.

This time, it's almost impossible for the yield curve to invert, since the Federal Reserve has been keeping short-term rates near zero. But the yield on 10-year Treasury notes has fallen sharply in recent days, a potential warning sign of economic weakness ahead.