The December 2023 market risk update highlights ongoing recession risks, with historical correlations between recessions and market downturns. It notes a significant rise in margin debt and market complacency, indicating potential vulnerabilities as the economy continues to expand. The document emphasizes the importance of monitoring these indicators as we approach 2024 amidst an evolving economic landscape.

1. The Independent Market Observer
Monthly Market Risk Update
December 2023

2. Recession Risk
• Recessions are strongly associated with market drawdowns;
8 of 10 bear markets have occurred during recessions.
• According to the National Bureau of Economic Research, the
last recession began in February 2020, at the start of the
pandemic, and ended soon thereafter.
• The economic expansion continued in November, with strong
hiring growth serving as a highlight. The primary risks are a
deeper slowdown in growth and tighter monetary policy from
the Fed.
Source: Institute for Supply Management, Haver Analytics
Risk
Level

3. Economic Shock Risk
• A major systemic risk factor is the price of money, otherwise known
as interest rates.
• Interest rates drive the economy and financial markets; historically,
they’ve also played a key role in market downturns.
• So, let’s take a closer look at the yield curve.
Source: Institute for Supply Management, Haver Analytics

4. Spread Between 10-Year U.S. Treasury and 3-Month U.S. Treasury
Yield Curve
(10-Year Minus
3-Month
Treasury Rates)
Source: Haver Analytics
As of November 30, 2023
Risk
Level

5. Yield Curve (10-Year Minus 3-Month Treasury Rates)
continued
• The yield curve inversion increased in November. The
3-month yield fell from 5.59% at the end of October to 5.45%
at the end of November. The 10-year yield fell from 4.88%
to 4.37%.
• This now marks 14 consecutive months with an inverted
3-month 10-year yield curve. This doesn’t guarantee that the
economy will enter a recession, but this widely monitored
signal could indicate further slowdowns.
Risk
Level

6. Market Risk
• Beyond the economy, we can also learn quite a bit by examining the
market itself. For our purposes, two things are important:
1. To recognize which factors signal high risk
2. To try to determine when those factors signal that the risk
has become an immediate concern
• Here, we’ll review valuations, margin debt, technical factors, and
market complacency.

7. Source: Standard & Poor’s, Robert Shiller, Haver Analytics
Note: Due to data limitations, the valuation data is the same as last month’s update. As of October 31, 2023
The Shiller P/E ratio (Shiller Cyclically Adjusted Price-to-Earnings Ratio) is defined as price divided by
the average of 10 years of earnings (moving average), adjusted for inflation.
Stock Price Index: Standard & Poor’s 500 Composite
EOP, 1941-43=10
Valuations:
10-Month
Change in
Shiller P/E
Shiller Cyclically Adjusted S&P Price-to-Earnings Ratio
10-Month % Change
Risk
Level

8. Valuations: 10-Month Change in Shiller P/E
continued
• Looking at the 10-month change in the Shiller cyclically adjusted
price-to-earnings ratio is a good gauge of immediate risk.
• When the change drops below zero over a 10-month or
200-day period, the market typically drops shortly thereafter.
• On a 10-month basis, valuations rose 8.56% in September.
Risk
Level

9. Source: Standard & Poor’s, Haver Analytics
As of December 15, 2023
Stock Price Index: Standard & Poor’s 500 Composite
EOP, 1941-43=10
Margin Debt
as % of
NYSE Market
Capitalization
FINRA Margin Debt as % of NYSE Market Capitalization
% Change Year-to-Year
Risk
Level

10. Margin Debt as % of NYSE Market Capitalization
continued
• Spikes in debt levels typically precede a market drawdown.
• Margin debt as a percentage of market capitalization
increased on a year-over-year basis in October and
November, with November’s 7.36% increase marking the
largest rise in margin debt since May 2021.
Risk
Level

11. Source: Standard & Poor’s, Haver Analytics
As of November 30, 2023
Stock Price Index: Standard & Poor’s 500 Composite
EOP, 1941-43=10
Technical
Factors:
200-Day and
400-Day
Moving
Averages
S&P 10-Month (200-Day) Moving Average
S&P 20-Month (400-Day) Moving Average
Risk
Level

12. Technical Factors: 200-Day and 400-Day
Moving Averages continued
• We start to pay attention when a market breaks through its
200-day average; a breakthrough of the 400-day average
often signals further trouble ahead.
• Technical factors supported major U.S. equity markets in
November. All three indices ended the month above their
respective 200-day moving averages.
Risk
Level

13. S&P 500 Forward P/E Divided by VIX
Market
Complacency:
S&P 500
Forward P/E
Divided by
VIX
Source: Haver Analytics, FactSet
As of December 15, 2023
Risk
Level

14. Market Complacency: S&P 500 Forward P/E
Divided by VIX continued
• Often, high valuations (forward P/E) signal investors are confident
and potentially complacent. When volatility (VIX) is high, there is
less complacency.
• Periods of high valuations and low volatility cause peaks in the
index (e.g., 2000, 2006–2007, and 2017); market drawdowns
occurred roughly one year after those peaks.
• Market complacency increased notably, with the index rising from
0.95 in October to 1.23 in November. The VIX fell from an average
of 18.89 in October to 14.08 in November.
Source: Institute for Supply Management, Haver Analytics
Risk
Level

15. Conclusion: Market Risks Remain
• The rebound for markets in November was welcome, but it’s
important to note that real market risks remain.
• The rise in margin debt and market complacency are worth
monitoring as we head into 2024, as both indicators were
downgraded to end the year.
• Ultimately, the path back to normal will likely be long, with
setbacks along the way.
Source: Institute for Supply Management, Haver Analytics
Risk
Level

16. Certain sections of this commentary contain forward-
looking statements that are based on our reasonable
expectations, estimates, projections, and assumptions.
Forward-looking statements are not guarantees of future
performance and involve certain risks and uncertainties,
which are difficult to predict. Past performance is not
indicative of future results.
Diversification does not assure a profit or protect against
loss in declining markets. All indices are unmanaged, and
investors cannot invest directly in an index.
The information contained herein is provided for
informational purposes only and is based upon sources
believed to be reliable. No guarantee is made as to the
completeness or accuracy of the information.
Disclosure