Is the US stock market sending a recession signal? Investors are pinning their hopes on the earnings season to "save the day." Is the decline just noise?

US small-cap stocks and industrial stocks are currently declining, which is usually a signal of an economic recession. However, given the better-than-expected performance of the stock market this year, some investors believe that these fluctuations are just noise - at least for now. The S&P 500 Industrial Index peaked on August 1st and has since fallen by about 8%. This decline came after several major US airlines lowered their third-quarter profit expectations due to a sudden surge in oil prices. The Russell 2000 Index, which represents small-cap stocks, has fallen by over 11% since its closing high on July 31st, roughly twice the decline of the S&P 500 Index during the same period. Significant declines in small-cap stocks and industrial stocks typically occur when the economy enters a recession.

There are other troubling signs in the stock market as well. The S&P 500 Index is on track for its first quarterly decline in a year and has just experienced its worst week since the collapse of Silicon Valley Bank on March 10th. Since the Federal Reserve announced its "higher for longer" policy stance last Wednesday, the index has fallen by 2.8%. Bank of America strategists point out that in response, global investors are withdrawing funds from stock funds at the fastest pace since December last year.

Having said that, there is still hope for the US stock market. Earnings season is approaching, and according to one model, this may have a greater impact on stock prices than interest rates. Bloomberg data shows that third-quarter US corporate profits are expected to decline by only 1.1% and then show growth at least until next year. In addition, the Federal Reserve stated this week that it expects US economic growth to be stronger than previously expected a few months ago.

Kim Forrest, Founder and Chief Investment Officer of Bokeh Capital Partners, said, "We only have a few weeks left in earnings season, and we haven't seen many companies lowering their profit and revenue guidance. We don't know when a recession will come - it may eventually come - but the largest US companies are not sending imminent threat signals."

For some investors, the recent decline is just a buying opportunity. Forecasters surveyed by Bloomberg predict that economic growth will slow down by mid-next year and then rebound.

Ed Clissell, Chief US Strategist at Ned Davis Research, said, "It is still too early to say that the stock market is signaling a recession. If we are heading in that direction, it seems to be in a very early stage, but we need to wait a few more weeks to see where the momentum will go towards the end of the year. His company has set the year-end target for the S&P 500 index at 4,500 points and predicts that the United States may experience an economic slowdown in the first half of 2024.

The decline in small-cap stocks may indicate expectations of slowing economic growth. Historically, these companies are the first to hit bottom before the broader market rebounds. They have close ties to the domestic economy and often have less diversified business scopes compared to their larger counterparts. Therefore, betting on these companies carries higher risks during periods of economic uncertainty.

One complex factor to consider when observing signals like small-cap stocks is that the stock market has already experienced a significant rally before the recent downturn. As of July 31, the S&P 500 index had surged nearly 20%. Therefore, although the index has since fallen by nearly 6%, it still has a long way to go to give back all the gains from 2023, and it is currently unclear what could trigger a substantial decline.

Another challenge is history. Ryan Detrick, Chief Market Strategist at Carson Group, pointed out that in the past three instances when the S&P 500 index fell by at least 1% in August and September, it rebounded in October: it rose by 8% in 2022, 8.3% in 2015, and 11% in 2011. Looking back to the 1950s, out of the 10 times when the index fell by more than 1% in August and September, 9 times saw an increase in October.

In addition, Jeff Cianci, Director of Research at Catherine Avery Investment Management, stated that infrastructure spending and the relocation of more production capacity back to North America by US companies are helping industrial companies generate more business, which is income that is less dependent on interest rates. Cianci said, 'The industrial stocks and commodities we have bought are undervalued compared to their true worth. The market is digesting recession risks that we have not seen.'