Home| Features| About| Customer Support| Request Demo| Our Analysts| Login
Gallery inside!
Markets

7 Big Clues That the Stock Market is Heading for a Recession

November 4, 2024
minute read

When investors are as optimistic about the stock market as they are currently, it’s prudent to consider what could go wrong. Some early signs emerged in the latest U.S. jobs report for October, which underperformed already reduced expectations, partially due to poor weather.

This might hint at forthcoming challenges in the labor market, potentially pushing the economy into a recession by mid-next year, according to Doug Ramsey, Chief Investment Officer at The Leuthold Group and co-portfolio manager of both the Leuthold Core Investment Fund and the Leuthold Global Fund. If this downturn materializes, stock prices will likely suffer, as recessions are typically detrimental to bullish market momentum. Ramsey, who recently referred to the current investment environment as “perilous,” believes a recession is probable, though not likely until around mid-2025.

Ramsey’s skepticism about the U.S. job market existed before the October data release. He viewed the robust September jobs report, which many took as a sign of economic resilience, as a temporary anomaly. “It wasn’t a stellar report. There are underlying issues with the employment numbers,” Ramsey observed.

Four Key Concerns

Recessions Often Follow Presidential Elections: Historically, U.S. recessions frequently begin in the year following a presidential election. Over the past century, eight recessions started the year after an election, six began during the election year, and two occurred in midterm years. None, however, started in the pre-election year. This pattern suggests that incumbents may stimulate the economy ahead of elections to gain voter support, creating a subsequent economic downturn or “hangover” the following year.

High Valuation Risks: Although valuations alone are not an ideal market timing tool, they do indicate possible market trends. Currently, the S&P 500 is trading at a forward price-to-earnings (P/E) ratio of around 22, a level only consistently surpassed during the dot-com boom of 1999-2000 and the stimulus-fueled rally in 2021. “Valuations are so high that I’d stay well below my maximum equity allocation,” Ramsey said, noting that mid-cap and small-cap stocks are comparatively more affordable. If U.S. markets reverted to long-term median valuations, the S&P 500 could drop 26%, mid-caps might fall 14%, and small-caps could slip by about 3%. Ramsey doubts that corporate earnings and profit margins will grow robustly enough to justify current valuations, as some analysts predict.

Lingering Impact of Aggressive Monetary Tightening: While the Federal Reserve has recently cut interest rates, the previous aggressive rate hikes may still weigh on the economy. Starting in early 2022, the Fed increased rates by more than five percentage points, bringing the federal funds rate to 5.5% as of last August. Ramsey believes that it will take multiple rate cuts to offset the effects of this rapid tightening, as monetary policy shifts generally take at least a few quarters to influence economic conditions.

Persistent Inflation Risks: Despite a strong S&P 500 rally over the past year, typically upswings of this magnitude coincide with higher unemployment. This is not the case now, as unemployment remains low. When joblessness is high, stock market gains have a limited effect on consumer spending; however, with low unemployment, asset price inflation can spill into consumer prices. Ramsey cautioned that inflation “may not be as dead as everyone thinks,” suggesting that the Fed might need to halt rate cuts if inflation stays elevated, raising the chances of a recession.

Three Emerging Warning Signs

Ramsey has identified concerning signals within employment data:

Rising Unemployment Rates: Over the past year, the number of unemployed people has risen by 13.7%. Historically, when this rate of increase surpasses 10%, the economy is often on the verge of or already in a recession. To account for the volatility in employment numbers, Ramsey examines the year-over-year rate of change in the three-month moving average.

Decline in Full-Time Jobs: As of September’s end, full-time employment was down 0.5% from a year prior—a trend typically observed only during recessions. Many companies appear hesitant to hire full-time staff, opting instead for part-time workers, which generally reflects a lack of business confidence and leads to reduced income for employees, as part-time positions usually offer lower pay and fewer benefits.

Stalling Employment Growth: Nonfarm payroll growth has nearly dropped to a level historically associated with recessions. When this growth rate falls below 1.4%, recessions often follow. With October’s growth rate at just 1.35%, Ramsey considers this “stall speed,” indicating an economic slowdown. Lower job and income growth can diminish demand, which then leads to further reductions in employment growth, setting off a negative economic cycle. Ramsey argues that this data undermines the view that the September jobs report eliminated recession risks.

Reasons for Optimism

While Ramsey’s outlook is cautious, he notes several factors that could challenge his recession forecast:

  1. Stock prices typically remain stagnant or fall significantly in the year before a business cycle peak. However, the S&P 500 has surged approximately 35% over the last year, suggesting that a peak might not be imminent.
  2. Since 1927, U.S. markets have generally continued to climb after a 30% gain over the prior 12 months, with an average additional gain of 14% in the following year.
  3. Despite elevated investor sentiment, it has not reached extreme levels, which could act as a contrarian sell signal. For instance, Bank of America’s “sell-side indicator” shows that Wall Street strategists recommend a 56.7% stock allocation on average, just 1.4 points shy of a typical sell signal in contrarian terms.

Overall, Ramsey believes sentiment is “pretty subdued” considering the strong market performance over the past year.

Tags:
Author
Eric Ng
Contributor
Eric Ng
Contributor
John Liu
Contributor
Editorial Board
Contributor
Bryan Curtis
Contributor
Adan Harris
Managing Editor
Cathy Hills
Associate Editor

Subscribe to our newsletter!

As a leading independent research provider, TradeAlgo keeps you connected from anywhere.

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Explore
Related posts.