S&P 500 – growth amid ghosts of recession

U.S. stocks started the quarter higher, despite the inversion of Treasury yields that heralded a recession. But despite the objective problems that play for the bears, the market’s seasonality plays for the bulls – for more than 70 years, April has been the most growing month.

Major US stock indexes ended the first quarter of 2022 in the “green zone“. The Dow Jones Industrial Average rose 0.4%, while the S&P 500 and Nasdaq Composite indexes rose 0.34% and 0.29% for three weeks, respectively. But it was out of breath. If not for the jump in the last hour of trading when closing short positions before the last weekend of the first quarter of 2022, this would have been the first week of decline.

Inversion of the yield curve

There is nothing strange about this state of affairs. The first 11 days of growth have already seen one of the most dramatic “bear market rallies” in history. Moreover, the last week’s main events occurred in the bond market. And they weren’t encouraging.

On the last quarter’s Monday, for the first time since 2006, the yield on U.S. Treasury bonds with a maturity of 5 years was higher than that of 30-year ones. Under normal circumstances, longer issues bring in more than short-term ones, so this rare anomaly, known as an inversion of the yield curve, always attracts attention. Moreover, it is believed that it predicts recessions. Last time, the economic downturn came next year.

But sceptics immediately started talking about the fact that it is better to monitor 2-year and 10-year papers-this is a more reliable signal. And the inversion itself quickly disappeared (although it remained in other spreads considered even less significant). But on Tuesday, those who did not believe the oracle earlier found it harder to find arguments – the inversion came to the U.S. 10 Year Treasury with the U.S. 2 Year Treasury.

Such phenomenon preceded each of the last eight recessions (since 1969), including (to some, it seems a coincidence or mysticism) and the economic downturn during the pandemic.   This phenomenon has preceded the last eight recessions (since 1969), including (to some, this seems like a coincidence or a mystery) the economic downturn during the pandemic. There was, however, one false signal. But if it can trust history, there is every chance that this GDP growth cycle will end between 6 months and two years.

Sceptics, of course, believe that they should not trust it. This time, they say, everything is different — unprecedented stimulus measures have distorted yields, thus “distorted” the signal. In addition, in their opinion, the inversion was short-term. Maybe it wasn’t there at all – Bloomberg and Reuters noticed it, but CNBC, no matter how much it searched, could not find it on Tuesday, according to its statement.

Naturally, the Fed also belonged to the sceptical financial camp. It still has the bulk of the process of tightening monetary policy amid record inflation, and the market is already trying to pull it back. On the eve of inversion Week, its website posted an article stating that “the supposed omniscience of the 2-10 spread that permeates market commentary is probably false.” The best harbinger is a spread with fewer than two years of maturity.

When will the recession start?

However, the data provided did not refute the previous facts of “omniscience”. It was just a different statement of the Fed’s position. When near-term bond rates are meagre, we should only look at the yield curve’s slope in its shortest-term part. Then, indeed, tightening monetary policy becomes not so scary.

“It seems that the near end of the curve shows a completely different picture than the far end,” Mark Heppenstall, president and chief investment officer of Penn Mutual Asset Management, said on CNBC. “I think that the market has accelerated to take a lot of rate increases, and in some ways, it takes into account the more significant risk of a mistake in Fed policy”.

In the future, the inversion appeared and disappeared at different times. But the last week of March ended with a complete victory for the oracle – both U.S. 2-Year Treasury U.S. and 5-Year Treasury yields are now higher than 10-year and 30-year bonds. The argument about short-termism has disappeared, leaving only a significant one – “this time, everything will be different.”

At the same time, inversion was not always such a bad sign in the short term for the stock market. The growth of stocks in 2006, for example, was delayed until October 2007. And last time, the indices grew almost until the recession, collapsing only at the end of February 2020.

But the rise of stocks in the U.S. has historically always ended before the recession is also a fact. Sometimes it reached its peak a week before it, and on average – about six months.  

The risk has increased dramatically

But now, some grounds are needed to continue growing, and they were also terrible in March. Now it only got worse. This week’s data on employment and inflation provide new arguments for a faster tightening of the Fed’s monetary policy. Bonds “warn” of a recession. The new reporting season, according to analysts, will show a sharp slowdown in profit growth. And all this right after one of the fastest rallies in history.

“The Fed is aggressively tightening policy; the rate of return will start to worsen, which is the end of the cycle. So while we don’t think there will be a recession this year, the risk of a recession next year has dramatically increased,” Mike Wilson, chief equity strategist at Morgan Stanley, told Bloomberg.

And perhaps the only thing that supports growth is the seasonality of the U.S. stock market. It, however, is not as small as it may seem. April is historically one of the most vital months for stocks. The last decline in the S&P 500 index was observed at the end of 2012, and the growth was even during the global financial crisis at the end of the “zero’s”.

Over the past 20 years, April has shown an increase of 80% of cases, and since 1946 – 70%. At distances comparable to a century, the index is among the top three in average profitability, although its composition varies for different periods. So, on the last business day of the first quarter of this year, LPL Financial chief strategist Ryan Detrick told Reuters that, according to his calculations, April had shown the best results among all months since 1950. In general, the phenomenon is well-known.

How to explain it is another matter. But whether it is necessary to do it? Some researchers claim that their regression analysis did not show a statistical relationship between months and S&P 500 returns. In other words, “a beautiful accident”. Some scientists provide scientific justifications for calendar anomalies, which also sound good. But traders usually do not demand all this from market participants, especially when the latter work entirely unscientifically.

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