Has the Market Bottomed?

By Adam Thurgood on April 26, 2023

Time flies when you’re having fun!  We’re nearly four months through another year and equity markets have had a fun ride so far.  As of the week ending 4/22, the S&P 500 was up 6.6% and the tech-heavy Nasdaq was up a whopping 16.6%.  The face-ripping rally that we have seen since the October 2022 lows has left a lot of people wondering if the worst is behind us.  To answer to that question, one needs to answer another; will there be a recession?

Going back 50+ years, we have not seen a market bottom before the Fed hiking cycle ended when a recession was on the horizon.  In fact, in most cases the market bottomed well after the Fed started cutting rates to combat the recession.  The chart below depicts the Fed Funds rate in blue and the S&P 500 in orange (in the upper panel) and the S&P 500 drawdown in the lower panel. The red bars represent recession.  A quick look tells a couple interesting stories. 

First, the Fed cuts rates in recession.  Over the past 50 years, every time we’ve had a recession, the Fed Funds rate fell well below its recent peak.  This makes sense.  The Fed is reactive and moves to protect the economy and markets when times are tough. This shouldn’t be news to anyone. 

Second, the S&P 500 doesn’t tend to bottom until well into recession and after the peak in Fed Funds has been reached.  The black dotted lines show the peak in the Fed Funds rate and in every instance the peak occurred before the recessionary bottom in markets.  There are other instances where a recession did not materialize after a peak in the Fed Funds rate.  In these instances, markets weren’t all that bothered.  Thus, the big input to the puzzle of whether markets have bottomed is in the call of whether a recession is headed our way.

When I look at the set of leading indicators I find most valuable, the probability of a recession looks quite high.  The Conference Board’s index of leading indicators is always a great place to start.  I look at the year-over-year change in the index to gauge probabilities of recession.  Both the duration of negative readings and the magnitude of decline are important to consider.  When we look back at history, we’ve always seen a recession materialize when we’ve seen a run of this many negative readings.  Additionally, we’ve always seen a recession occur when the index fell to levels where we sit today.  As such, the index is screaming that a recession is coming.

Another interesting metric to watch is the market implied short-term interest rate 18 months from now versus the current level of rates.  If the market expects 3-month treasury rates 18 months into the future at lower levels than today, the market is signaling that economic weakness is coming.  When we look at the current setup, it’s ugly!  The market is expecting the 3-month treasury yield in 18 months to be 1.8% lower than it is today.  In historical terms, that’s a massive shift and signaling problems are on the horizon. 

This chart also has some important information to help answer our overarching question.  As we can see over the course of time, when we have a reading below about -0.5%, a recession has typically followed.  Additionally, the market has never bottomed before this measure has reversed higher when heading into a recession.  In fact, the bottom in the stock market has occurred well after the spread bottomed out and turned higher.  We have no sign at this point that the bottom in the spread has taken place, which again signals the market bottom has yet to occur.

With markets up strongly year-to-date it is safe to say that the market doesn’t believe a recession is coming.  In my view this creates greater risk for markets if the leading indicators pointing to recession are correct, which is why we have dialed back risk and added to hedges as equities have rallied. 

We plan to dive further into the weeds on the economy and markets in our upcoming May client briefing.