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Will the Third Shoe Drop

Today the S&P 500 Index broke above 3000 for the first time in anticipation the Federal Reserve Chairmen Jay Powell will lower interest rates in July. If interest rates are lowered, this will be the third shoe to drop indicting the stage is set for a possible recession.

In the Stock Market Update posted on June 3, 2019, we listed three things that we are watching because each have occurred prior to the previous recession over the past 32 years.

Inverted Yield Curve


The yield curve is inverted meaning you earn higher returns on short-term investments than you do on longer-term investments. 

Low Unemployment


Prior to previous recessions, unemployment was at low levels. Unemployment recently hit 3.6% which is lowest level in 49 years. Periods of low unemployment suggest we have reached a peak in the economic expansion and the only direction from here is higher unemployment as the economy starts to contract.

A Peak in Interest Rate


This is the last shoe to drop as we now wait for guidance from the Feds. If the Feds lower interest rates in July, it means the rate increases that started in 2015 will turn down – thus creating a peak in interest rates.

From a technical basis, the S&P 500 Index finally broke above its two previous highs which is a bullish signal; however, the three shoes we are watching may be signaling the bull may soon run its course.

Morgan Stanley, which has one of the biggest equity research divisions on Wall Street recently indicated the outlook for markets is very poor over the next three months. Equity prices are way too high given deteriorating manufacturing and economic data. The expectations for interest rate cuts are now priced into the market leaving little room from here for price appreciation.

The bond market usually moves in the opposite direction of the stock market. When stocks go up bonds go down. However, there are times when stocks and bonds trend together as they are doing now. Even though stocks are currently advancing, the bond market is suggesting an economic slowdown in the future. Money is flowing to the safety of bonds. Stocks and bonds trending together usually doesn’t happen in a strong bull market.

It is difficult to say when a recession will start but Noah didn’t build the ark when it started to rain.