The Bear Is Back – 3 Signals to Watch for a Market Bottoming

DEWITT, Mich. - Oct. 3, 2022 - PRLog -- Markets pricing in a new base-case scenario: Economic downturn

Over the past several weeks, and especially since the last FOMC meeting, market volatility has reemerged. The S&P 500 has entered bear-market territory once again, down about 23% for the year. And while there had been debate around whether the economy could emerge from this tightening cycle in a "soft landing," financial markets now broadly seem to be pricing in a new base-case scenario: A recession is on the horizon (see chart below).

Perhaps the silver lining here is that a pending recession has been well advertised by many market participants, including Fed Chair Jerome Powell. As Powell noted in his last press conference, "The chances of a soft landing are likely to diminish to the extent that policy needs to be more restrictive, or restrictive for longer." And now the focus may shift to when and how deep a potential economic downturn may be.

Barring any external shocks to the system – which are typically difficult to handicap – we do not yet see the scope for a deep or prolonged recessionary environment in the U.S. The labor market continues to show resilience, the banking and financial system are structurally sound (and in better shape than prior to the great financial crisis in 2008), credit markets appear orderly, and the economy is less reliant on foreign energy sources than others around the globe. Last week we did see stress in the U.K. credit markets that caused the Bank of England to step-in and stabilize markets. While credit markets in the U.S. have not shown similar signs of distress, the probability of a financial disruption rises as central banks continue to aggressively raise rates.

What history tells us about returns during shallow downturns

While every cycle is unique, history can offer some guideposts on returns around recessionary periods. Historically, market downturns in average or shallow recessions tend to be around -25% to -35%, and last around 10 to 15 months. The recovery period can also range from nine months to two years. Keep in mind that in deep recessions, the losses and recovery times can nearly double, but typically they are accompanied by some structural or systemic issues, which have not yet emerged in the U.S. economy. With equity markets down over 20% currently, much of the work to the downside may have been put in already, as financial markets price in the economic downside ahead.