Dipping Closer To The Tipping Point

The digital ink was barely dry on this morning’s post, which discussed the relationship between the S&P 500’s rolling one-year price return and the onset of recessions, when Mr. Market went into one of rare but far-from-unprecedented hissy fits. By the end of the day’s trading, the S&P had a new haircut with a price tag that pinched the numbers by 4.8%. What does it mean for the market’s forecast on the macro outlook? The good news is that even after today’s rout, the S&P 500 is still up roughly 6.5% vs. a year ago on a price basis. The bad news is that the margin of comfort is fading—fast, at least by today’s standard.

A bit of history: Every recession in the past 50 years has been associated with year-over-year declines in the equity market. Samuelson’s famous warning that the stock market had forecast nine of the last five recessions is still relevant. But this particular defect in prognosticating isn’t worrisome at this point. Indeed, the risk in looking to the market is that it may see an approaching recession (as implied by a one-year decline in price) when in fact there’s no such beast on the horizon. Perhaps the most infamous example is the 1987 stock market crash, which led to double-digit annual market losses well into 1988 but without a corresponding recession.
Given recent conditions, ours is a different problem in the current climate, namely: There’s never been a recession in the modern era without the market suffering an annual loss. As we move closer to a loss, no one’s losing any sleep over the possibility that the market’s wrong. We should be so lucky.
The notion that the market is a pretty good judge of the macro trend, albeit a flawed judge, has been discussed for years. Geoffrey Moore wrote about the dance between the market and macro back in 1975 and Jeremy Siegel penned an intriguing essay on the topic in 1991, for instance.
As for the latest round of selling, the market trend hasn’t rolled over in annual terms, but we’re a lot closer to zero than we were yesterday. One indicator is hardly fate, which is why it’s usually hazardous to evaluate one factor–any factor–in a vacuum. But if the broad market gauges keep falling to the point that one-year performances sinks below zero, it would surely be one more dark sign.