Executive Summary

• New bear market + re-enter recession = 30-40% drop in stock prices
• What are the chart of the best technical indicators telling us?
• Confusion reigns during the transition from bull market to bear
• Why volatility will reign & capital protection should be prioritized

If you have not yet read Part 1: Has The Market Trend Shifted From Bull To Bear? available free to all readers, please click here to read it first.

It’s The Global Economy, Stupid!

I believe another key question for equity investors right now is whether the recent noticeable slowing in global economic trajectory ultimately results in recession.  Why is this important?  According to the playbook of historical experience, stock market corrections that occur in non-recessionary environments tend to be shorter and less violent than corrections that take place within the context of actual economic recession.  Corrections in non-recessionary environments have been on average contained to the 10-20% range.  Corrective stock price periods associated with recession have been worse, many associated with 30-40% price declines known as “bear market” environments.

We can see exactly this in the following graph.  We are looking at the Dow Jones Global Index.  This is a composite of the top 350 companies on planet Earth.  If the fortunes of these companies do not represent and reflect the rhythm of the global economy, I do not know what does.  The blue bars marked in the chart are the periods covering last two US recessions.  US recessions that were accompanied by downturns in major developed economies globally.  As I’ve stated many a time, economies globally are more interlinked and intertwined than ever before.  We live in an interdependent global world.  Let’s have a closer look. 

If we turn the clock back to late 1997, an emerging markets currency crisis caused a 10%+ correction in global stock prices, but no recession.  The markets continued higher after that event.  In late 1998, we’ll remember that the blow up at Long Term capital Management really shook the global markets causing a 20% price correction, but no recession as the markets continued higher into the early 2000 peak.  From the peak of stock prices in early 2000 to the first quarter of 2001, prices corrected just over 20%, but then declined yet another 20% that year as the US did indeed enter recession.  The ultimate peak to trough price decline into the 2003 bottom registered 50%, quite the bear market.  Again, accompanied by recession. 

The 2003 to early 2008 experience is similar.  We saw 10% corrections in 2004 and 2006, neither of which were accompanied by recession.  The markets continued higher post these two corrective interludes.  Late 2007 into the first quarter of 2008 witnessed just shy of a 20% correction, but being accompanied by recession meant the peak to trough price decline of 2007-2009 totaled well over 50%

We again see similar activity in the current environment.  In 2010 we saw a 10% correction and no recession.  In 2011, we experienced a 20% correction.  Scary, but no recession meant higher stock prices were to come. 

And so we now find ourselves at yet another of these corrective junctures and the key question remains unanswered.  Will this corrective period for stock prices be accompanied by recession or otherwise?  I believe this question needs to be answered from the standpoint of the global economy, not the US economy singularly.  For now the jury is out, but we know evidence of economic slowing outside of the US is gathering force.  China is a specific focus due to its meaningful impact on the emerging economies as well as Europe, Japan and the US.  The Dow Jones Global Index has corrected 12% from its recent early 2015 peak.  Trajectory from here very much depends on the forward path of the global economy.