Financial Markets What do the financial markets indicate about the possibility of an upcoming recession? The answer is: there might be a recession, but then again there might not be a recession. The table below shows the annual returns of three major U.S. stock indexes since 2018: 1) the S&P 500 – a diversified index that measures the stock performance of 500 relatively large companies (it is a “large-cap” index, generally comprised of companies having a total stock value exceeding $10 billion), 2) the NASDAQ – an index comprised of over 3000 companies listed on the NASDAQ stock exchange and heavily weighted toward technology, and 3) the Russell 2000 – a diversified index that measures the stock performance of 2000 relatively small companies (it is a “small-cap” index, generally comprised of companies having a total stock value less than $2 billion). For comparative purposes, the long-run average annual return (since 1926) is approximately 12 percent on large-cap stocks and 16 percent on small-cap stocks. Stock prices reflect expectations of future profitability. Theoretically, the stock market is a leading economic indicator. After an abysmal 2022 reflecting growing economic uncertainty and rising interest rates, stock market performance, although somewhat mixed, has generally rebounded in 2023 and appears to reflect at least some economic optimism. In particular, the S&P 500 and NASDAQ have posted relatively good year-to-date returns through late April, with the S&P 500 up over 5% and the NASDAQ increasing over 13%. However, the Russell 2000 was slightly down, and a decline of 1% in March retail sales reflected a slowing economy and contributed to economic uncertainty.
U.S. Stock Market Returns (Source: Morningstar)
2018 -6.24 -3.88
2019 28.88 35.23 23.72
2020 16.26 43.64 18.36
2021 26.89 21.39 13.70
2022
2023*
S&P 500 NASDAQ
-19.44 -33.10 -21.56
5.64
13.26 -1.75
Russell 2000
-12.18
*year-to-date return as of April 26
Contrary to the somewhat mixed signals of the stock market, the bond market tells a different tale regarding economic expectations. Historically, the yield curve has been a pretty good indicator of pending recessions. The yield curve is a graphical representation of the term structure of interest rates. In other words, the yield curve shows the relationship between short-term and long-term interest rates for securities with equal default risk, but different maturities. The yield curve is “inverted” when short-term rates are greater than long-term rates. Specifically, the spread (difference) between the yield on long-term (ten-year) U.S. Treasury securities and the yield on short-term (either 2-year or 3-month) U.S. Treasury securities has been used as a predictor of recessions, with an inverted yield curve generally signaling a pending recession. Both measures have been referenced in the financial and business media as predictors of recessions. Both measures have been excellent predictors of recessions, but not perfect. The chart below shows the Treasury yield curve on April 26, 2023. Both the 2-year and 3-month yields have recently been greater than the 10-year yield; each comparison would predict an upcoming recession. The yield curve was slightly inverted when the 10-year yield (3.43%) is compared to the 2-year yield (3.90%), and when the 10-year yield (3.43%) is compared to the 3-month yield (5.16%).
Treasury Yield Curve Rates
Date 30 Yr 04/26/23 3.91 5.07 5.16 5.00 4.64 3.90 3.65 3.46 3.45 3.43 3.81 3.70 1 Mo 2 Mo 3 Mo 6 Mo 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr
Central Wisconsin Report - Spring 2023
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