Stock market pullbacks happen. The normal equity risk of pullbacks is the price investors pay for better long-term performance. But a recent analysis by Oxford Economics found that the average S&P 500 pullback during non-recessionary periods is -15.4% and -36% during recessions.
Here is why this matters for equity investors. The recent peak-to-trough drawdown for the S&P 500 was about -10%. If there is no recession, the downside risk is relatively limited. However, Fed Funds futures expect five quarter-point rate hikes in 2022, with some strategists calling for as many as seven. The current rate of expected tightening will push the 2s10s yield curve to invert in late 2022 or early 2023, which would be a recession signal. Markets look ahead 6-18 months. A 2023 recession translates into an equity bear market in 2022. Suddenly, the recent -10% S&P 500 decline could become a prelude to a vicious bear market.
Ominously, the path of the stock market is following the pattern of 1982. In 1982, the economy was in recession. CPI was 7% and the Fed had been hiking aggressively. It was a mid-term election year and the second year of the Presidential Cycle. The market experienced a down January and saw a bearish turn-of-year barometer (TOY) signal.
The key difference between today and 1982 is the recession question. With all of the G7 central banks except for the BoJ turning hawkish, can the Fed rescue the stock market from the 1982 analogue by engineering a soft landing?
The full post can be found here.
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