Technician Warns of Impending Bear-Market Recession for Stocks

As U.S. stocks continue to reach new yearly highs, concerns about an impending bear-market recession are being raised by Tyler Richey, co-editor at Sevens Report Research. Despite the Dow Jones Industrial Average (DJIA) and the S&P 500 index (SPX) closing at fresh 2023 highs, Richey emphasizes that the deeply inverted yield curve is a cause for caution. In a recent report, he pointed out that most Treasury spreads have inverted to levels not seen since the early 1980s, signaling potential trouble ahead due to excessive Federal Reserve rate hikes in a short period.

Richey highlights five key signals that investors should monitor to identify the onset of a recessionary bear market for stocks. The first signal is a bull-steepening dynamic in the yield curve, particularly if the spread between the 10-year and 2-year Treasury moves above -83 basis points. This would indicate a further steepening dynamic and potential economic challenges. Additionally, a considerable widening of high yield spreads, represented by the ICE BofA U.S. High Yield Spread, surpassing 100 basis points toward 5%, could serve as a warning sign.

Another signal to watch is a meaningful rise in the Cboe Volatility Index (VIX) confirmed by a spike in the Put/Call Ratio in the derivatives market. An increase in the VIX, which measures implied volatility based on S&P 500 options, along with a rise in the put/call ratio suggesting investors are seeking downside protection, could indicate increasing market uncertainty. Moreover, investors should be vigilant for backwardation in the term structure of the VIX, where front-month VIX futures rise above back-month futures prices, potentially signaling heightened hedging demand from sophisticated investors.

Lastly, Richey advises keeping an eye on the dollar index (DXY), as a sharp rise in the index could imply risk-off money flows affecting global markets. Although timing this signal may be tricky, surpassing the late-May high of 104.2 against a basket of rival currencies might indicate further strength for the dollar.

As investors navigate the current market landscape, these five signals could play a crucial role in identifying potential risks and preparing for a possible bear-market recession in the future.