Beware the Bear: Technician Warns of Potential Stock Market Recession

As U.S. stocks continue to soar to fresh yearly highs, concerns loom over the possibility of an impending recessionary bear market, as brought to light by Tyler Richey, co-editor at Sevens Report Research.

According to Dow Jones market data, the Dow Jones Industrial Average (DJIA) and S&P 500 index recently achieved record highs in 2023, hovering within a 4.5% range of their all-time peaks.

Despite recognizing the ongoing rally and positive equity trend, Richey takes a cautious approach, dubbing it “patient bears” due to the deeply inverted yield curve. This observation sounds an alarm, with most Treasury spreads now inverted to levels unseen since the early 1980s. This inversion suggests that the Federal Reserve’s more than 500 basis points of rate hikes in less than 18 months might have been excessive for the economy to endure.

Richey points out five critical signs that can aid investors in detecting potential early signals of a recessionary bear market for stocks:

1. A Bull Steeper of the Yield Curve: Investors should closely monitor a sharp bull-steepening dynamic in the yield curve, particularly if the spread between the 10-year and 2-year Treasury moves above -83 basis points, indicating the likelihood of further steepening. As per FactSet data, the 2-year Treasury yield was at 4.85% on Monday, while the 10-year was closer to 3.96%.
2. Considerable Widening of High Yield Spreads: A warning sign arises if the ICE BofA U.S. High Yield Spread rises over 100 basis points from current levels towards 5%. As of July 28, this spread stood nearly 3.8% above the risk-free Treasury rate, according to Federal Reserve Economic Data.
3. Meaningful Rise in the VIX Confirmed by Put/Call Ratio: A significant increase in the Cboe Volatility Index (VIX), coupled with a sudden spike in the put/call ratio, indicates growing options demand for downside protection. The VIX, measuring implied volatility based on the S&P 500, recently exhibited a rise of +3.45%.
4. Backwardation in the Term Structure of the VIX: A rise in front month VIX futures above back month futures prices may imply an escalated hedging demand among sophisticated investors.
5. Sharp Rise in the Dollar Index: A strengthening dollar, surpassing the late-May high of 104.2 against rival currencies, such as the DXY, signals potential further upside for the greenback, indicating risk-off money flows affecting global markets.

In an ever-changing market landscape, vigilance and awareness of these indicators can be instrumental in guiding investors through potential shifts in market conditions.