Last week, we discussed
the seemingly unstoppable bullish trend from the October 2022 lows.
“The market rebounded mid-week from the
disappointing inflation report but stumbled again on Friday after producer
inflation. The market’s momentum remains strong, and investor optimism is
very high. The only question is what causes a short-term correction to
reduce the deviations between the market and the 200-DMA.”
The rally continued this past week, spurred higher by Nvidia’s blowout earnings
report Wednesday night. After a brief test of the 20-DMA, the market surged to
new all-time highs on Thursday, confirming the ongoing bullish trend. As shown,
the 20-DMA continues to act as crucial support for the market.
The negative divergence in both momentum and breadth (chart
below) continues to be of concern, suggesting a short-term correction is
likely. With the bulk of earnings season behind us, the focus will return to the
Fed and the economy.
Given the more speculative action taking place in the options market, it is
clear that bullish sentiment continues to remain elevated. Historically, the
combination of negative divergences and bullish sentiment previously led to
short-term corrections. As such, we suggest remaining somewhat diligent on risk
We don’t know what will eventually lead to a market correction, but one will
ultimately occur to reverse the more extreme deviation from the 200-DMA. With
the market becoming more aligned with the Federal Reserve’s expectations for
rate cuts, the current outlying risk for equities is an economic slowdown that
At the moment, that is a very non-consensus worry. Most economists have swung
from expecting a recession to giving up on that call. Such would include the
Conference Board this past week.
Conference Board Scraps Its Recession Call
Eventually, the pressure of being “wrong” gets
to everyone. For stock investors, the markets are famous for “dragging
the last of the holdouts” back into the market just before it does indeed
correct. For economists, recession calls that don’t mature impact their
credibility. As we wrote in October, “Economists
No Longer Expect A Recession.” To wit:
“In the latest quarterly survey by The Wall
Street Journal, business
and academic economists lowered the probability of a recession within the next
year, from 54% on average in July to a more optimistic 48%. That is the
first time they have put the probability below 50% since the middle of last
As of January, the probability dropped to just 39%. Of course, since the WSJ has
been collecting the data, the surveyed economists continue to be spectacularly
wrong, as they, just like investors, get swept up in short-term momentum and
Unsurprisingly, this is the case for the Conference Board. This past week, it
finally succumbed to an economy that continues to avoid a recession. To
“The Conference Board on Tuesday
abandoned a long-running call for the U.S. economy to fall into recession,
although its Leading Economic Index still sees economic output flatlining in
the months ahead. The Conference Board first announced in July 2022 that the
index signaled a recession was coming. It repeated that forecast with each
month’s report until Tuesday’s release for January, even as U.S. economic
output, job creation, and consumer spending all continued at above-trend
levels throughout, and no recession materialized.”
The chart below is the raw Leading Economic Index from the Conference Board
versus GDP. Each previous decline in the index has aligned with a recession.
According to the Conference Board, the reason for the retraction of the
recession call was the improvement in underlying indicators.
“While the declining LEI continues to signal
headwinds to economic activity, for the first time in the past two years, six
out of its 10 components were positive contributors over the past six-month
period. As a result, the leading index currently does not signal recession
ahead.” – Justyna Zabinska-La Monica, The Conference Board.
The LEI index comprises, as noted, 10 subcomponents, as shown in the chart
below. The most significant positive contributor to the turn from a recession
forecast came from the recent surge in stock prices to record highs. The
benchmark S&P 500 index has risen by more than 20% since late October after
signals from the Federal Reserve that its aggressive interest rate cycle aimed
at containing inflation is over and that rate cuts are expected this year.
Furthermore, persistently low numbers of new filings for unemployment benefits
and measures of future credit availability, home building permits, and new
orders of manufactured goods also contributed to the change in the outlook.
As noted, the biggest contributors were the leading credit index (which has
improved with the drop in interest rates) and the surge in the S&P 500 index.
Given that the Conference Board’s Leading Index suggests where the economy will
be in 6-months, the stock market tracks the index. Currently, the stock market
is very detached from the index.
However, therein lies the risk. The Federal Reserve has been adamant that their
inflation fight is NOT over yet, as noted in the most recent FOMC minutes.
“Participants generally noted that they
did not expect it would be appropriate to reduce the target range for the
federal funds rate until they had gained greater confidence that inflation
was moving sustainably toward 2 percent.”
Such brings up Rule #9.
Farrell’s Important Rule
Bob was a Wall Street veteran with over 50 years of experience crafting his
investing rules. Farrell obtained his master’s degree from Columbia Business
School and started as a technical analyst at Merrill Lynch in 1957. Even
though Farrell studied fundamental analysis under Gramm and Dodd, he turned to
technical analysis after realizing there was more to stock prices than balance
sheets and income statements. Farrell became a pioneer in sentiment
studies and market psychology. His
10 rules on investing stem from personal experience with dull
markets, bull markets, bear markets, crashes, and bubbles. In
short, Farrell had seen it all and lived to tell about it.
Regarding Wall Street experts, Rule #9 is the most important.
all the experts and forecasts agree, something else will happen.“
With the Conference Board giving up its recession call, all the “experts” from
Wall Street to the “Ivory Towers” of
economics are in the “no recession” camp.
It is an interesting switch, given that in 2022, all the experts expected a
recession in 2023. But here we are in 2024 with “not
a recession in sight.”
But this is where it is interesting. The Conference Boards index has had
negative readings for the last 23 months. That is just one month short of
negative readings in 2008.
The first negative reading of the index was in April 2007. As shown in the chart
below, in April 2007, there was no hint of a recession in the economic data.
Employment was strong, and even in early 2008, Ben Bernanke, then Fed chairman,
stated that it was a “Goldilocks” economy
and that “subprime mortgages” were
Notably, it wasn’t until 21 months later that the National Bureau of Economic
Research (NBER) declared the recession began 12 months earlier, in December
Could a recession still be in our future?
Risk Of A Recession Is Not Zero
With the stock market surging and financial conditions loosening, there seem to
be valid reasons to suspect we may avoid a recession. As noted by the Conference
Board, unemployment remains low, along with jobless claims, and confidence has
improved markedly in recent months.
However, historically, the NBER has been very late in determining the start and
end of a recession. Such will likely be the case as they wait for data revisions
and clear evidence of a recessionary economic downturn. With the economy still
growing, there is no need for a recessionary call.
The economy’s strength is unsurprising, given the ongoing financial stimulus
from the Inflation Reduction Act, the CHIPS Act, and a surge in deficit
we discussed recently, deficit spending keeps the economy out
“As noted, the problem remains on how
the economy has avoided a recession despite the Fed’s aggressive rate hiking
campaign. Numerous indicators, from the leading economic index to the yield
curve, suggest a high probability of an economic recession, but one has yet
to occur. One explanation for this has been the surge in Federal
expenditures since the end of 2022 stemming from the Inflation Reduction and
CHIPs Acts. The second reason is that GDP was so grossly elevated from the
$5 Trillion in previous fiscal policies that the lag effect is taking longer
than historical norms to resolve.”
We see that same support to economic activity in the monetary supply (M2) as a
percentage of the economy. While those monetary and fiscal supports caused
economic growth to surge following the “pandemic-related” spending
spree, both are reversing.
Crucially, it was worth noting that the massive surge in economic growth is
reversing as those monetary supports fade. However, given that the reversal in
economic growth started from the highest annualized growth rate since 1959, the
reversal of that stimulus-induced surge will require more time.
As such, without additional fiscal or monetary stimulus to offset the
restrictive period of monetary policy, the risk of recession in the next 12-24
months is not zero.
Yield Curve Still Says There Is A Risk
The question of a “soft landing” or an
outright “recession” is difficult to
answer. It is certainly possible that all of the tell-tale signs of economic
recession may be wrong this time. There is another possibility. Given the
massive increase in activity due to a shuttered economy and massive fiscal
stimulus, the reversion may take longer than expected. Both scenarios support
the rising optimism of Wall Street economists in the near term.
We would already be in a recession if we had entered this current period at
previous growth rates below 4%. The difference is the contraction began from a
peak in nominal GDP of nearly 12%. As noted above, a bounce in activity is not
surprising after a significant contraction in the economic data. The question is
whether that bounce is sustainable. Unfortunately, we won’t know the answer for
quite some time.
We know that Federal Reserve actions regarding hiking rates have about a
6-quarter lead over changes to economic growth. Given that the last Fed rate
hike was in Q2 of last year, such would suggest a further slowing in economic
activity by the end of 2024.
While the Conference Board has abandoned its recession call, the bond market has
not. The yield spread between the 10-year and 2-year Treasury Bonds remains
deeply inverted. Notably,
the inversion is NOT the recessionary warning. It is when that
yield-curve UN-inverts that signals the onset of a recession. Such has
historically occurred in response to Federal Reserve rate cuts to try and offset
a rapidly slowing economy.
The views expressed by Lance Roberts are not
necessarily those of RetireEarlyLifestyle.com