Despite U.S. stocks reaching fresh yearly highs, there are growing concerns of an impending recessionary bear market, as highlighted by Tyler Richey, co-editor at Sevens Report Research.
The Dow Jones Industrial Average (DJIA) and S&P 500 index recently closed at 2023 highs, coming within a 4.5% proximity of their all-time records, according to Dow Jones market data.
While acknowledging the ongoing rally and positive trend in equities, Richey maintains a cautious approach, referring to the stance as “patient bears” due to the deeply inverted yield curve. This observation raises alarm as most Treasury spreads have inverted to levels unseen since the early 1980s, indicating that the more than 500 basis points of Fed rate hikes in less than 18 months may have been excessive for the economy to withstand.
Richey identifies five crucial signs that can assist investors in identifying the potential onset of a recessionary bear market for stocks:
- A Bull Steeper of the Yield Curve: Investors should closely monitor a sharp bull-steepening dynamic in the yield curve, particularly if the spread between the 10-year and 2-year Treasury moves above -83 basis points, signaling the possibility of further steepening. As of FactSet data, the 2-year Treasury yield was at 4.85% on Monday, with the 10-year closer to 3.96%.
- Considerable Widening of High Yield Spreads: A warning sign emerges if the ICE BofA U.S. High Yield Spread rises more than 100 basis points from its current levels toward 5%. As of July 28, this spread stood nearly 3.8% above the risk-free Treasury rate, according to Federal Reserve Economic Data.
- Meaningful Rise in the VIX Confirmed by Put/Call Ratio: A significant increase in the Cboe Volatility Index (VIX), along with a sudden rise in the put/call ratio, would indicate rising options demand for downside protection. The VIX, measuring implied volatility of options based on the S&P 500, recently showed a rise of +3.45%.
- Backwardation in the Term Structure of the VIX: The rise of front month VIX futures above back month futures prices may imply sophisticated investors’ increased hedging demand.
- Sharp Rise in the Dollar Index: A firming dollar and a break above the late-May high of 104.2 against a basket of rival currencies, such as the DXY, could indicate further upside for the greenback, reflecting risk-off money flows impacting global markets.
In a constantly evolving market, vigilance and awareness of these indicators can help investors navigate potential shifts in the market environment.
[Disclaimer: The information provided is for educational and informational purposes only and should not be considered as financial or investment advice. Always do your own research and consult with a qualified financial advisor before making any investment decisions.]
