The risk of a US bear market is higher than a year ago

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The current bull market reached its 10-year anniversary this June, making it the longest bull market run in modern history. Understandably, this makes investors nervous. Everyone remembers the mayhem of 2008 – and with the prices of shares at all-time highs, especially in the US, the fear of a recession is a valid concern for many investors.

There’s a prevailing myth that if you’re smart enough, you can predict the market’s moves and avoid its downfalls. In reality, no one can time the market with perfect accuracy.

“During the current bull market, there have been dozens of calls for stock market crashes from even very seasoned investors. None of these came true, and if you’d listened to these experts, you would have missed the subsequent upside,” says Adriaan Pask, CIO at PSG Wealth.

While it is difficult to accurately predict a bear market, one can still watch for signs and mitigate risk. To do this, PSG Wealth’s research team developed a proprietary South African bear market indicator. In 2018 it indicated that the risk for a US recession was moderately high. Since then the risk has increased.

“In the past few months, the US yield curve inverted on various occasions, but subsequently bounced back. On 19 July, the yields for 3-month (2.04%) and 10-year (2.05%) Treasury bonds finally rose after both inverted in May this year. This is an example of why it is so difficult to make accurate forecasts,” says Pask.

US markets at progressively higher risk of a bear market since 2017

The current lack of inflation and inflation expectations in the US is one of the factors that supports a much longer economic cycle and less volatility. In the absence of inflationary pressure, monetary policy may remain much looser and reduce the risk of a recession and a bear market.

“For us, the yield curve and output gap are particularly important to watch,” says Pask.

“While the output gap is not yet in high risk territory according to our index, it is higher than last year. If the output gap continues to rise, it means that the potential for growth in the US economy cannot be sustained, which increases the risk of a possible recession and the probability of bubbles forming in certain sectors of the economy.”

“If inflation and wage growth remain contained at current levels, we believe the US economy could run for a bit longer. We do, however, believe it is in a late cycle.”

“We will continue to watch the output gap, wage growth and inflation. If wages start to rise, combined with the low unemployment rate in the US, it could lead to higher inflation. An increase in inflation could signal the countdown to a US recession,” warns Pask.

South Africa is currently in the safe zone

Looking at the local market, PSG Wealth’s bear market index is currently at an overall level of 32%, three percent higher than a year ago, and just above the safe zone of between 30% and 70%.

“There is currently no real concern of a correction in our domestic market,” says Pask.

However, South Africa is at the mercy of developments in developed economies.

“Any recession, or major correction, in one or more developed economies will likely dominate any of the positive factors in the South African economy, with the same effects on our equity market,” says Pask.

Investors should remember that the rand’s weakness coincides with US stock market pullbacks. This is a crucial consideration for local investors who are concerned about elevated valuations of US stock markets.

If US markets are to experience a pullback, it is likely that it will coincide with a weakening of the rand, which should offer some diversification properties for rand denominated assets.