Market Insights: High Anxiety
Should we be scared? It is October. The Wall Street Crash of 1929 (kick-off to The Depression) began in October. Black Monday was in October 1987. In October of 1997, there was a stock market crash caused by economic crisis in Asia. The start of the Great Recession began in October 2007.
The stock market keeps moving steadily higher. When some investors look down, they feel high anxiety. We keep hearing the length of the current economic expansion is pushing up against previous historic records. Could we be teed-up for another October collapse?
Sharp stock market pull-backs of -5%, -10% and -20% occur frequently during bull markets and are to be expected. Typically, the stock market recovers in a matter of months from a run-of-the-mill decline. What we worry about is not so much a normal market correction, but an extended bear market drawdown that requires years to recover from.
Extended bear markets occur during recessions. If you would like to avoid a major bear market, first check to see if there is a recession likely in the intermediate term and second, reduce equity exposure.
Last week, we published an updated Leading Economic Index (LEI) chart that includes data through August 2017. For the past twelve months, the LEI has been consistently positive. From the LEI standpoint, there is no sign of a recession.
Historically, the LEI shows significant deterioration months before a recession. Shown below is the most recent example of the LEI providing ample warning before the 2007-2009 recession.
The treasury yield spread between the 10-year and the 2-year rate is also a reliable early indicator of impending recession. Although the spread between the 10 and 2-year is tightening, it is nowhere near inverted.
The chart above is the history of this relationship since 2006. Another way to look at the spread is to compare the yield curves on a single day. In the chart below on February 23, 2006, the 2-year was 4.72%, above the 10-year rate of 4.56% - inverted. Today, the 2-year is 1.47%, below the 10-year rate of 2.33% - not inverted, steep. Prior to recessions, we have seen inversions.
Again, market corrections are a normal part of bull markets. We could see a consolidation or correction in October, we may not. What we are not afraid of at this time is the beginning of a major bear market. Pullbacks should be bought.
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Delta Market Sentiment Indicator (MSI) is published weekly in Barron’s