Recession or Not? We Could Be in the Eye of the Storm

After suffering the worst six-month loss in over 50 years the S&P 500 and other indexes stabilized and then rallied for two months only to face more volatility to the downside. In fact, after the most recent inflation figures were released on Sept. 13, the S&P fell more than 4% – its worst single-day drop since 2020.

It’s very likely that the downturn we have been experiencing will get much worse and the bear market is likely not over.

And the problem this may create for stock investors is summed up in a quote by famed investor Peter Lynch: “You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready. You won’t do well in the markets.”

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One Major Sign We’re in a Recession

So, are we in a recession or not?

In the first two quarters of this year we have had two negative quarters of GDP, which is the “unofficial” definition of a recession. The official determination rests solely with the National Bureau of Economic Research – and only with the benefit of hindsight.

A safer bet may be to trust that the two quarters of negative GDP means we are likely in a recession. Charlie Bilello of Compound Capital Advisors pointed out that the last 10 times we’ve seen two consecutive quarters of negative economic growth going all the way back to 1947, the U.S. was indeed in a recession.

Seven Other Recession Red Flags Waving Right Now

Besides this pattern there are other red flags pointing to a further slowdown:

1. Housing has been a major driver of economic growth over the past two years but now appears to be slowing dramatically due to recent rate hikes, according to InvesTech Research.
2. The National Association of Home Builders reported that both the Builder Confidence Survey and the Traffic of Prospective Buyers Survey continue to crater as rising home prices and decade high mortgage rates are keeping potential buyers on the sidelines. The association went on to state that conditions have gotten so bad that we’re now in a “housing recession,” which could seriously contribute to the depth and duration of an economic recession.
3. The2-year versus 10-year Treasury yield curve recently inverted once again, meaning that the shorter-term investment is actually yielding more than the longer-term investment. Historically this inversion signals a recession. The last time it inverted this much was the year 2000 after which the S&P 500 fell another 48.1% to the eventual bottom. Of course, it doesn’t mean it will play out the same way this time but investors who ignore such a red flag do so at their own peril.
4. The University of Michigan Consumer Sentiment Index hit a reading of 50 in June which was a “70-year low,” and it’s still hovering around that level. The average reading is close to 90 and every time it has dropped anywhere near current levels since 1964, it has always been accompanied by a recession. In spite of positive reassurances from economists and Fed officials this would historically cement any question as to whether or not we are in a recession.
5. Also keep in mind that aggressive rate hikes by the Fed have historically led to a recession, because such action slows economic growth and causes unemployment to rise. The current rate hikes are occurring at a pace and magnitude not seen since the early 1980s. This includes two 75 basis point rate hikes in both June and July. The last time the Fed raised rates 75 basis points prior to this was 28 years ago.
6. Remember also that rising interest rates cause earnings of companies to decline, which in turn causes their stock prices to decline. BlackRock, the largest money manager in the United States, in their August 15 weekly commentary stated that “the risk of disappointing earnings is one reason we are tactically underweighting stocks.”
7. Finally, according to InvesTech Research, the most volatile years in the stock market occur in bear markets, and some of the bigger bear markets have seen 1% to 2% swings on nearly half the trading days in the calendar year. If we extrapolate the number of 1%-2% moves in the S&P 500 so far in 2022 for the full year, we are in rarefied air. In fact, if this pace of volatility continues it will be comparable to some of the most severe bear markets of the past 60 years (1973 -1974, 2000-2002, 2008-2009).

The Bottom Line for Investors

In spite of all of these major red flags pointing to a recession, could we still be near a market bottom heading for a soft economic landing? It’s possible but not likely.

If you have concern about the market, it may be time to have a meeting with your financial adviser and see what you can do to reallocate your portfolio to make it more protected in case of further declines.