Empirics prove – recessions likely when stock market crashes.

The next stock market crash could easily kick-start a recession, and the underlying reason is that stocks are shares of ownership in a corporation. As a result, the stock market reflects investors' confidence in the future earnings of all the companies listed. Corporate earnings are dependent on the health of the U.S. economy, and that sometimes makes the stock market a leading indicator for the U.S. economy as a whole.

Stock market crashes can reduce business financing and consumer confidence, both of which can cause recessions.

These types of crashes typically occur after periods of irrational exuberance, when investors stop caring about whether a stock's price accurately reflects the company's value.

Crashes don't always lead to recessions, especially when the government steps in to cushion the blow on key segments of the economy.

Panic selling is one of the worst ways you can react to a market crash.

Effects of Market Crashes

A crash signals a massive loss of confidence in the economy, and when that confidence is not restored, it leads to a recession. A crash also frightens consumers into buying less. That's a huge hit to the economy since consumer spending is the largest component (70%) of gross domestic product (GDP).1

A crash also means less financing for new businesses, as the sale of stocks provides companies the funds they need to grow.

Lastly, a declining U.S stock market slows global economic growth. First, it will cause the other stock indexes to decline, although a recession might not follow a crash right away.

For example, in the first quarter of 2007, the Dow Jones Industrial Average fell more than 600 points in one week, but it recovered during the year and rose to a high of 14,000 in October. Although the crash did not cause a recession, it did signal that one was coming.