What An Increasing Recession Probability Means For The Stock Market

As the S&P 500 stalls at its 200 day moving average, recession probabilities are rising according to the New York Fed. Let’s look at what this means for the stock market.

Let’s determine the stock market’s most probable medium-term direction by objectively quantifying technical analysis. For reference, here’s the random probability of the U.S. stock market going up on any given day.

*Probability ≠ certainty. Past performance ≠ future performance. But if you don’t use the past as a guide, you are blindly “guessing” the future.

Recession probabilities

The New York Fed has a model that predicts the probability of a U.S. recession within the next 12 months. It is based on inverting the 10 year – 3 month Treasury yield curve.

According to this indicator, the probability of a recession is 23% right now.

Is this bad news for the stock market?

Here’s every single month in which the NY Fed’s Recession Probability Indicator exceeded 23%, overlapped onto a chart of the S&P 500

Here’s what happens next to the S&P when the Recession Probability Indicator exceeds 23%, for the first time in 1 year.

As you can see, the stock market’s forward returns deteriorate 1-1.5 years later. This is more of a problem for stocks in 2020 than in 2019

NASDAQ breadth

If you think the S&P 500’s breadth is strong, just look at the NASDAQ’s breadth.

Such strong breadth is not something you typically see in bear markets.

Here’s what happens next to the S&P 500 when more than 90% of NASDAQ 100 stocks are above their 50 dma

Here’s what happens next to the NASDAQ 100 when more than 90% of NASDAQ 100 stocks are above their 50 dma

In both cases, this factor is quite bullish for stocks 2-12 months later.

*Take this study with a grain of salt. The data is limited back to 2002, so we don’t know what this breadth indicator did in the 2000-2002 bear market

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Our discretionary outlook is not a reflection of how we’re trading the markets right now. We trade based on our quantitative trading ...

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