3 Charts to Watch If You’re Concerned About the Next Bear Market

0
186

The current bull market in equities has dragged on for nearly a decade. But, all good things eventually come to an end, and this bull market will inevitably at some point turn into a bear market.

Loading...

Load Error

But, when will that happen? Everyone was concerned about a bear market in October. The S&P 500 dropped more than 7% during October on concerns that rising rates and bigger tariffs would kill what had already turned into a slowing U.S. economy. But, since then, hawkish Fed members have grown increasingly dovish, including Fed Chairman Jerome Powell, and that has significantly lessened the risk of rising rates killing this bull market. Meanwhile, there’s a lot optimism out there that the U.S. and China will reach some sort of trade agreement at their next meeting, thus postponing the risk that bigger tariffs kill the market.

All together, the S&P 500 is flat in November, and up 4% over the past several days as these positive developments have come to light. That means the S&P 500 is now just 6.5% off its all-time highs, a far reach from bear market territory, which is defined as a 20% plunge from recent highs.

So, back to the question, when will the next bear market happen? Not right now. But, investors should be mindful that a bear market could spring up over the next 12 to 24 months.

In order to better predict the timing of a bear market, investors should be watching credit markets, debt levels, and GDP growth. Specifically, investors should be watching three charts which have historically proven to be solid indicators of a coming bear market.

What are those charts, and what are they saying right now? Let’s take a closer look.

The 10-2 Treasury Spread

a close up of text on a white background© Provided by InvestorPlace

Where It’s At Right Now: 0.22%

What Level Is Worrisome:

Perhaps the most tried and true indicator of a bear market is the spread between the 10-Year and 2-Year Treasury Yields. Typically, the 10-Year Yield is higher than the 2-Year Yield, meaning that investors expect economic growth in the near future to remain healthy. But, as credit markets grow increasingly bearish about the economy’s growth prospects, investors sell near-term Treasury securities and buy long-term ones, pushing short-term yields higher and pulling long-term yields lower.

When this dynamic becomes extreme, the yield curve inverts, meaning short-term yields surpass long-term yields. When this happens, there is almost certainly a bear market right around the corner. In each of the past three major recessions, a yield curve inversion preceded the economic downturn.

Right now, the 10-2 spread is low, as can be seen in the attached chart from YCharts. It sits at 0.22%. But, that isn’t negative, and bull markets have persisted for long stretches at a low but not negative 10-2 spread — the entire 1990’s in fact. As such, this indicator says that the bear market isn’t here just yet.

Corporate Net Debt to GDP

a screenshot of a cell phone© Provided by InvestorPlace

Where It’s At Right Now: 34.5%

What Level Is Worrisome: ~37%

One thing all major recent bear markets have in common is a yield curve inversion. Another thing is too much debt.

But, on the debt front, investors should be specific in their focus. Typically, government and personal debt aren’t great indicators of a bear market. Instead, the big indicator is corporate debt, because that reflects how levered up U.S. companies are, and the stock market is a collection of those U.S companies. Also, to gauge corporate debt levels, investors typically look at corporate debt to GDP. But, as Moody’s points out, the better indicator is net corporate debt to GDP, because this discounts liquid assets which can be used to buffer against leverage.

Right now, corporate net debt to GDP hovers around 34.5%, according to the attached Moody’s chart. That is above the long term median level (33.2%). But, it is also below where corporate net debt to GDP stood during each of the last three major economic downturns. During those downturns, corporate net debt to GDP hovered around 37%. Thus, at 34.5%, U.S. corporations aren’t disturbingly levered up just yet.

Moreover, during other debt burble bursts, the Fed Funds effective rate was consistently above 5%, and typically much higher. Today, that ate is just 2.2%, and presumably not heading much higher thanks to a dovish Fed. Perhaps this low interest rate is why — despite above average net debt to GDP levels — the high yield default rate is near a long-term low.

U.S. Real GDP Growth Trend

a screenshot of a cell phone© Provided by InvestorPlace

Click to Enlarge

Where It’s At Right Now: 3.05%

What Level Is Worrisome:

The third thing that has preceded the last three major U.S. economic recessions is rapidly slowing GDP growth. Broadly speaking, the U.S. economy doesn’t go from red-hot to ice-cold overnight. Instead, the U.S. economy tends to have a slowing growth trend that eventually turns into a recession — and a bear market for stocks.

Specifically, the average real GDP growth rate for the U.S. economy since 1980 is 2.64%. Prior to two of the previous three major recessions, the stock market peaked when the GDP print was below 2.64%. Prior to all three recessions, the stock market peaked when GDP growth was materially slowing from above-trend growth, or growth rates above 2.64%.

We don’t have either of those characteristics today. Instead, real GDP growth last quarter was above-trend at 3.05%. Meanwhile, real GDP growth is actually improving from a multi-quarter streak of below-trend growth, not falling from a multi-quarter streak of above-trend growth as it did in 1990, 2000, and 2007.

Overall, this chart isn’t all that bearish for stocks at the current moment. If we see real GDP growth start to cool meaningfully here and start to run below 2.6%, then the chart gets bearish. Until then, though, the U.S. real GDP growth trend remains favorable for stocks.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

2018-11-30 12:12:24

Read more from source here…

LEAVE A REPLY

Please enter your comment!
Please enter your name here