3 Signals That the Recession May Have Bottomed

June 12, 2020

AFTER MONTHS OF ECONOMIC DISRUPTION related to the coronavirus, the National Bureau of Economic Research made it official on Monday: The United States is in a recession that began in February.¹ Yet on the same day, the S&P 500 climbed back to higher levels than at the start of 2020.² What does that tell us? “Despite some of the biggest and sharpest economic declines on record and continuing volatility, we believe this recession has already reached its bottom,” says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. “Normally, that takes six months or more.”

Bolstered by unprecedented government stimulus and Federal Reserve actions, the strong markets of the last few weeks also reflect encouraging U.S. economic news, including stabilizing employment figures and improvements in manufacturing, auto and home sales and consumer spending, he says. While serious challenges undoubtedly remain—most notably concerns about a potential resurgence of the pandemic, which helped to drive markets down on Thursday—Hyzy and the Chief Investment Office team are closely following some key market measures that provide reasons for optimism. Here are three:

Cyclical versus defensive stocks. Companies in industries such as manufacturing, real estate and financial services are especially subject to ups and downs in the economy. Recently, these “cyclical” stocks have outperformed “defensive” stocks known for stable earnings and dividends in any conditions, Hyzy says. “That’s a sign the economy has bottomed out and is turning for the better.”

Clues from the yield curve. Interest rates for long-term bonds have risen recently in comparison with those for shorter-term bonds, Hyzy notes. A steeper yield curve—at a time when rates overall remain at historic lows and many investors remain bearish—may project market confidence in the long-term economy, he adds. “This is something we’ll be watching closely.”

The 20-day spike. Short-term stock performance may offer evidence about the market’s long-term prospects. “One measure we watch is the 20-day spike. About 66% of the S&P 500 stocks hit new 20-day highs,” Hyzy says. “When that number is higher than 60%, it’s a sign of momentum and there’s a better than 90% probability that the market return for the next 12 months could likely be positive,” he adds.

How can investors respond?
While these and other measures are useful in gauging where the markets may be headed, rapid buying and selling based on short-term data can be risky and counterproductive, Hyzy says. Your advisor can help you interpret market data and determine what impact it may have on your long-term decisions, he adds. “We suggest a balanced, diversified portfolio based on your long-term goals.” Investors may want to consider strategically adding cyclical stocks to their portfolios, as well as growth and value investments, he says. At a time when interest rates remain low, bond investors may want to consider investment-grade corporate bonds.