Early 2021 featured meme stock mania, stimulus checks, enhanced unemployment benefits and zero-percent interest-rate policy. As a result, the stock market boomed, interest rates were tame, and the U.S. economy went on to post its best growth rate, as measured by GDP, since 1984.
Now, inflation, the Fed and geopolitical risks have many people wondering if a recession is near. It’s not surprising with some of the recessionary indicators flashing yellow lights. At the same time, there are signs that the market meltdown of 2022 could be in the process of bottoming. It’s hard to tell which way we will break from here, and we could be in limbo for a while longer.
Consumer sentiment, the Treasury yield curve, economists’ growth expectations and investor sentiment all show signs of fatigue and underscore the possibility of a recession looming on the horizon. According to the University of Michigan, consumer sentiment has been declining since August, and in February it recorded its lowest reading since 2011 at 62.8. Readings at 65 or below often coincide with recessions.
As for the Treasury yield curve, a recent surge in the U.S. 2-Year Treasury Rate to above 1.8% leads many economists to point out the real risk of a dreaded inversion — when the 2-year rate climbs above the 10-year rate. Every recession since the mid-1960s was preceded by an inverted yield curve. We aren’t quite there yet, but Goldman Sachs says the yield curve’s current shape portends a 20% to 35% chance of a U.S. recession.
Several surveys of economists and money managers suggest the chance of a recession is approaching 40%. CNBC’s Fed Survey, released on March 15, shows 33% of respondents expect a recession in the U.S. this year. Moreover, the March Bank of America Global Research Fund Manager Survey revealed that a global recession is seen as the second-greatest market risk, behind only uncertainty associated with Russia’s invasion of Ukraine. Retail investors also feel less confident about the future, with the percent of those feeling “bearish” or expecting a decline in the market in the next six months remaining quite elevated from the historical average, according to the American Association of Individual Investors (AAII) data.
Clearly, several economic indicators are flashing yellow right now.
Recessions & bear markets: two different animals
Recessions happen when an economy endures at least two consecutive quarters of negative GDP growth. Bear markets in stocks are generally defined as a 20% decline. The two sometimes go together, but not always. Stocks are a forward-looking mechanism, which means they often move ahead of the economy.
Meanwhile, the stock market has already been in a protracted downturn. Many significant areas, such as the Russell 2000 small cap index, once high-flying tech names, and even the broad Nasdaq Composite have all breached the psychological 20% drawdown level. Even for the S&P 500, which has been the relative stalwart, 62% of its components are down at least 20% from their 52-week high. Internationally, emerging markets are currently experiencing their longest bear market since 1990.
Why this could be a bottom
All that information probably made you feel a bit depressed. How about some encouraging news? The sharp declines in the areas of the market discussed above appear to suggest that a slowdown in the global economy could already be accounted for (or priced in). Typically, a broadening out of the selling pressure across sectors can be a sign we're closer to the end of the selloff than the beginning.
Additionally, the dour sentiment-indicators mentioned above often precede a bottoming in the market. Sometimes they're even referred to as contrarian indicators. Another sign a bottom may be forming is the decline in the put/call ratio, which measures the number of bets being made on a decline in the market through options. That, along with the decline in the CBOE Volatility Index (or the VIX) suggests some fear has been removed from the market.
It often takes time for bear markets to bottom out. Sometimes a washout is needed to clear the weak hands and build a foundation for a sturdy market recovery.
Encouraged about the second half
The Russia/Ukraine war has put a lot of pressure on the market and added uncertainty about economic growth prospects. Talks of a possible peace deal have increased in the past few days, and while the situation continues to evolve, a resolution or de-escalation would remove a large question mark for investors.
This week we received more clarity on the Fed’s interest rate plans in the year ahead, which was supported by their expectations that the economy will remain strong. While the Fed’s 2022 GDP growth estimate was revised lower to 2.8%, it remains above the long-term average.
To be sure, we will need to keep an eye on the consumer as their confidence has been dinged. But I believe given their still-strong financial position, and the strength of the job market, it’s possible this could be a temporary blip in confidence. As we can put some of these near-term concerns behind us, the hope is that the second half of 2022 features a steadier global economy and easing inflationary pressures.
The bottom line
While recession fears have risen, several indicators suggest we could be getting close to the end of what has been an uncomfortable correction. As the market digests information over the next several months, things could smooth out, potentially making putting money to work at currently discounted prices a wise move for investors.
Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.