The economy and markets look like they did in 2000 again

An exceptionally robust job market. The Federal Reserve is raising interest rates at a rapid pace. Overheated financial markets are beginning to correct themselves, with the most bubbly sectors bearing the brunt.

This is the situation today — and so it was in the spring of 2000 when the dot-com bubble began to burst. A recession followed, but only a year later.

Why it matters: The year 2000 offers important lessons on the type of risks the economy faces – and what to look for to understand how bumpy the ride could be from here.

Flashback: The stock market peaked in March 2000. But as the year progressed, there were increasing signs that the good times for money-hungry Internet companies were drawing to a close.

• The layoffs started out as a trickle and grew into a torrent. IPOs were shelved and the stock prices of the companies that went public plummeted. Websites have sprung up to track “F*d” company burn rates and layoff plans.

Yes but: The overall economy has actually held up great this year. The vast majority of people didn’t work for dot-com companies, after all, and American businesses as a whole were still generally bullish about investing and hiring.

• The number of new jobless claims in April 2000 hit a decade-low and only rose seriously towards the end of the year. The unemployment rate ended the year at 3.9%, just a tenth above its April low.
• Inflation hit a 10-year high of 3.8% in March, and the Fed hiked interest rates by half a percent in May to curb inflation.

It was only in 2001, the wheels began to unravel from the broader economy as companies cut back on growth plans and layoffs became more common. Economists would eventually date the start of a recession to March 2001 – a full year after the stock market peaked.

• It was also an unusually mild recession — and might not have counted as a recession at all if the September 11, 2001 terrorist attacks had not happened. The attacks temporarily sent an already shaky economy into a tailspin – a reminder that geopolitical events can inflict even more economic pain when the situation is already dire.

The big picture: Taking the parallels between then and now seriously has some important implications for how the economy will perform in the coming months — and what to look for to know if a full-scale recession is occurring.

• Watch carefully for corporate behavior starting to change outside of the companies most directly affected by the stock market sell-off and crypto meltdown. It doesn’t matter much to the broader economy whether Robinhood or Coinbase lay off employees — but it’s a different story when the entire breadth of companies start doing the same or cutting back on their capital spending plans.
• Consumer demand drove the economy and was the reason the 2001 recession was so mild; there was not a single quarter this year in which private consumer spending fell. Given strong household balance sheets and rising wages, that appears to be the case this episode as well.
• Pay more attention to the corporate bond markets than the stock market. The real economic troubles of 2001 came when losses in the telecom sector triggered a wave of bankruptcies and prompted investors to sell all manner of corporate bonds – restricting the flow of credit in the economy, a key feature of the 2001 recession.

Just one thing: Be ready for the allegations. The receding economic tide two decades ago has exposed the deep rot of companies far removed from the dot-com boom, such as energy trading firm Enron and industrials firm Tyco International.

The bottom line: The US could avoid a recession this time. But when market sentiment reverses, as it did 22 years ago and now, it becomes more vulnerable to bad news.