Posted by Jeffrey Buchbinder, CFA, Chief Equity Strategist
Wednesday, June 7, 2023
We had hoped to write a blog about the “official” start of a new bull market today, but no such luck. The S&P 500 Index closed at 4,283 on Tuesday (and is trading around that level at noon ET Wednesday), falling just 0.25% short of a close at least 20% above the October 12, 2022 low of 3,577. In the grand scheme of things, there isn’t much difference between 4,283 and 4,292, but it does mean that our celebration of the new bull on LPLResearch.com will have to wait a little longer. Or, perhaps we’ll feature that topic in our next Weekly Market Commentary on Monday, June 12. Regardless, hopefully stocks will achieve that milestone soon.
Tuesday’s 0.24% gain in the S&P 500 wasn’t particularly exciting, but the 2.7% jump in the Russell 2000 Index hints at investors embracing risk and suggests we may start to see better breadth—positive signs that the new bull is probably not far off.
Before you pop those champagne corks, the elephant in the room amid this latest rally is that recession still appears likely to us within the next six to 12 months. Certainly a soft landing is still possible—last week’s blowout jobs report for May certainly helps make the case. But the economy has started to show some cracks, the bond market is pointing to recession with the yield curve still inverted (short-term interest rates are higher than longer term), leading economic indicators are strongly signaling recession based on history, consumer spending appears poised to slow as post-pandemic pent up demand dwindles, and the effects of higher interest rates and tightening financial conditions flow through the economy with a lag. In other words, the cards are stacked against this economy continuing to grow over the next year-plus.
If we assume recession is coming fairly soon, though it will likely be short and shallow, then what does that mean for stocks? As shown in the accompanying chart, stocks tend to not do all that well in the months leading up to an official recession. We looked at recessions back to the early 1970s to see how the S&P 500 Index performed during the 12, six, and three months before those economic downturns began. On average, six months before, the index has fallen 1.4%, though the median is slightly positive at 1.0%. Three months before recessions began, performance was a bit weaker, with an average and median decline of 1.6% and 3.8%, respectively.
Those aren’t horrible numbers. Some comfort can be taken from the fact that the worst returns were around the 2001 recession, which we would argue experienced a more severe bubble in the dotcom boom and was hit multiple times with the accounting scandals that followed. Also consider the more mild recessions in the early 1980s and 1990s saw stocks do quite well. On the other hand, stocks have historically bottomed during recessions, so gains leading up to the economic peak don’t necessarily mean stocks are out of the woods.
Keep in mind we won’t know until well after the fact whether an official recession has begun. Remember the National Bureau of Economic Research (NBER) is the arbiter of recessions and typically doesn’t date them until at least six months after they start. So, perhaps watching where stocks go over the summer may provide an early warning signal.
Bottom line, with elevated recession risk, a rally through the high end of our year-end fair value target range on the S&P 500 at 4,400 seems unlikely in the near term. And with bonds offering some of the richest yields in decades, the risk-reward for stocks is no longer compelling, in our view. Strong momentum may carry the market a bit higher from here, but our fair value range is just a fraction away and seems like a natural place for stocks to take a breather.
For more of LPL Research’s thoughts on the near-term outlook for stocks, see our latest Weekly Market Commentary here or listen to the LPL Market Signals podcast here.
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