Although the stock market has dipped sharply in the past without an adverse effect on the economy, falling stock prices adversely impact business and consumer sentiment. This can eventually spill over onto Main Street, as consumers postpone large purchases like automobiles, and businesses decide to hold off large investments.
“Drops in the stock market do not necessarily translate into a loss of confidence,” says Lynn Franco, director of consumer surveys at the Conference Board, a business research group in New York. “But you have to look at the political scenario, the downgrading of the US debt, and the longer-term repercussions. This will not instill confidence.”
The key factor will be how long the stock market falls. The longer the drop, the worse the impact on consumers’ psyche, says Ms. Franco.
The stock market plunge isn't the only disappointing economic news. On Friday, the Department of Labor reported the US economy added 117,000 jobs in July. Although this was higher than many economists had anticipated, it was still considered a “weak” reading, says Franco.
The soft economic data, combined with the falling stock market, increases the probability the US will slip into a recession, say some economists. Last week, for example, Standard & Poor’s estimated the odds had increased to 35 percent that the US would enter a recession, up from 30 percent.