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A paradox: A looming bull market amid a potential recession

These are very confusing times.

With many of the indices already rising more than 20% from their lows, it's understandable that most of us might already be thinking that we are now in bull markets.

At the same time, the economic data seems to be worrying and points towards a potential recession.

I subscribed to Bitcoin Monthly from ARK Invest (which I strongly recommend to anyone to subscribe to as it's free and contains many useful infographics) and here is some interesting data they have published.

First, the rapid decline of the Gross Domestic Income (GDI). I'm sure most of us have heard of Gross Domestic Product (GDP) but maybe not as many have heard of Gross Domestic Income (GDI). They are two slightly different measures of a nation's economic activity. In theory, GDP should be equal to GDI as every dollar earned in income should be used on goods/services and vice versa. While they might not always converge immediately as the data to measure both are obtained from different places, they almost always meet eventually. You can see there is a slight divergence now with GDI going down while GDP going up. For them to meet, it means either GDP needs to go down or GDI needs to go up. It is now likely that GDP will be going down- which points towards a recession.

Second, new manufacturing orders have been contradicting which signals a looming recession. Manufacturing activity has been on a constant decline over the past few months. When there is lesser manufacturing activity, it usually represents a drop in demand which will inevitably eventually lead to a drop in GDP and eventually a recession.

Last but not least, the inverted yield curve. This was not something highlighted in the Bitcoin Monthly by ARK Invest, but it's something that has kept investors on the toes since it inverted a year ago. Earlier this week, the yield curve hits its deepest inversion since 1981. An inversion of the yield curve represents unprofitable businesses for banks in issuing loans to businesses which makes it harder for businesses to expand and this hence slows the economy.

With the above reasons, it's not difficult to imagine a recession happening soon. And what usually happens to the stock market during a recession?

Below are some key data from The Motley Fool.

Since 2000, the S&P 500 fell an average of 18.58% over the entire course of a recession and took an average of 647 trading days (roughly 2.5 years) after the United States exited a recession to reach pre-recession levels.

During those periods of recessions, the S&P 500 fell an average of 38.61% from its highest level.

When you extend the data to 1945, the S&P 500 interestingly rose an average of 1% during all recession periods. You must be thinking what!

This is due to the fact that markets usually top out before the start of recession and bottom out before the end of recession.

Now, here's the paradox.

When it comes to looming recessions, the market is usually bearish. However, we are now actually facing bull market scenarios!

Why is this so?

I personally feel that this has a lot to do with interest rate hikes. As we know, we faced unprecedented quantitative easing after the pandemic. This results in high inflation which causes the Fed to come up with an equally unprecedented tightening cycle. With the high interest rates now, what are supposedly bad news have now become good news to the market. For example, poor employment data which usually happens during recession could be good news to the stock market now as it means that the Fed will start cutting interest rates. When the Fed starts cutting rates, the market will be in a triumphant mood and risk-on assets like stocks will start rising in prices again.

This will likely continue until the market starts to normalise to a new interest rate. When that happens, poor earning results (as a result of recession) by corporations might then start putting downward pressure on the market again. Right now, the positive impact of a lower interest rate triumphs the negative impact of poor earning results by corporations and hence the market is still so bullish.

Whatever it is, things go on. And I still do my regular investments. Once a year rebalancing my portfolio with regular DCA into the S&P 500 index via my SRS funds.

Of course, it will also be good to set aside some funds in case the market does start crashing and those times will then be a really good time to put those funds to use. I will write a more elaborate article on this next time.

I once polled my Telegram group if they think a new bull market has started. Results are pretty split. Interested to see more of such polls and participate in them? Join my Telegram channel. 180+ like minded individuals have already done so.

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