Stocks have fallen from their record levels at the end of 2021 with the S&P 500 flirting with correction territory, which is defined as a 10% drop (but less than 20%) from its most recent peak. The Nasdaq meanwhile is nearing a Bear market, which is when the market falls by more than 20% from its recent peak.
It’s impossible to predict whether a correction will turn into a bear market or when either will reverse. What we do know, though, is that investor sentiment turns hostile when the broader stock market tips into a correction or bear market. Stocks do even worse when we’re in a recession. And more and more economists are predicting a recession.
Why Do Analysts Expect a Recession?
The last recession, which occurred in early 2020, lasted just two months—from February to April. The U.S. economy has recovered significantly since then. Corporate profit margins are near record highs, the U.S. economy added nearly half a million jobs in March, and the unemployment rate is near record lows.
Despite all the good news there are an increasing number of red flags that analysts say point to a recession.
Over the last 75 years, every time inflation has exceeded four percent and unemployment has gone below five percent, the U.S. economy has hit a brick wall within two years. Today, inflation is near eight percent and the jobless rate tumbled to 3.6% in March.
The yield curve inversion is another red flag that points to a recession. The yield curve measures the spread between the cost of money and how much a bank will make by lending it or investing it over a longer period of time.
Longer-term government Treasury bonds yield move in the direction of short-term rates. But the spread between longer-term and shorter-term two-year bonds shrinks as rates rise. And few investors would want to invest in a longer-term bond when the yields on shorter-term bonds are higher. If financial institutions can’t make money, lending slows, and so does economic activity.
A yield inversion has been a solid indicator of an impending recession. The two-year/10-year spread was last in negative territory in 2019, right before the pandemic sent the global economy into a recession.
In fact, the two year/10-year yield curve inversion has predicted every recession since 1955, save for one false signal in the mid 1960s. There was a slowdown, but not an official recession.
The fact is that stagnant economic growth and soaring inflation can be a toxic combination. Economists at Deutsch Bank, Bank of America, Morgan Stanley, RBC Capital Markets, and CIBC have all said the risks of a recession have grown significantly.
While there are technically, no true recession-proof stocks—all stocks face some periods of volatility—there are defensive plays that do well during difficult circumstances. Healthcare companies, the utilities sector, and consumer staples are just some popular defensive stocks that do well during a recession.
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