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The Independent Market Observer
Monthly Market Risk Update
February 2024
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 January, 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
Economic Shock Risk
• A major systemic risk factor is the price of money, otherwise known
as interest rates.
• Interest rates have driven 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
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 January 31, 2024
Risk
Level
Yield Curve (10-Year Minus 3-Month Treasury Rates)
continued
• The yield curve inversion narrowed modestly in January due
to rising long-term interest rates. The 3-month yield rose from
5.40% at the end of December to 5.42% at the end of January.
The 10-year yield rose from 3.88% to 3.99%.
• This now marks 16 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
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.
Sources: Standard & Poor’s, as of January 31, 2024; Robert Shiller, Haver Analytics, as of October 17, 2023.
Note: Due to data limitations for the Schiller P/E index, the valuation data is the same as last month’s update.
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
Valuations: 10-Month Change in Shiller P/E
continued
• Looking at the 10-month change in the Shiller cyclically adjusted
price-to-earnings ratio can be a good gauge of immediate risk.
• When the change drops below zero over a 10-month or
200-day period, the market has tended to drop
shortly thereafter.
• On a 10-month basis, valuations rose 8.56% in September.
Risk
Level
Source: Standard & Poor’s, Haver Analytics
Note: Due to data limitations, the valuation data is the same as last month’s update. As of January 16, 2024.
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
Margin Debt as % of NYSE Market Capitalization
continued
• Spikes in debt levels have typically preceded a
market drawdown.
• Margin debt as a percentage of market capitalization
increased on a year-over-year basis in December for the third
consecutive month, with margin debt rising 8.7%.
Risk
Level
Source: Standard & Poor’s, Haver Analytics
As of January 31, 2024
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
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 can
often signal further trouble ahead.
• Technical factors supported major U.S. equity markets in
January. All three major indices ended the month above their
respective 200-day moving averages.
Risk
Level
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 February 9, 2024
Risk
Level
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, it
suggests that there is less complacency.
• Periods of high valuations and low volatility have caused peaks in
the index (e.g., 2000, 2006–2007, and 2017); market drawdowns
occurred roughly one year after those peaks.
• Market complacency fell slightly, with the index dropping from
1.53 in December to 1.51 in January.
Source: Institute for Supply Management, Haver Analytics
Risk
Level
Conclusion: Market Risks Remain
• The continued rally for markets in January was welcome and
helped start the year on the right foot.
• The rise in market complacency is worth monitoring, as the high
reading for the index signals potential concern.
• Ultimately, the path back to normal will likely be long, with
setbacks along the way.
Source: Institute for Supply Management, Haver Analytics
Risk
Level
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

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Monthly Market Risk Update: February 2024 [SlideShare]

  • 1. The Independent Market Observer Monthly Market Risk Update February 2024
  • 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 January, 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 have driven 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 January 31, 2024 Risk Level
  • 5. Yield Curve (10-Year Minus 3-Month Treasury Rates) continued • The yield curve inversion narrowed modestly in January due to rising long-term interest rates. The 3-month yield rose from 5.40% at the end of December to 5.42% at the end of January. The 10-year yield rose from 3.88% to 3.99%. • This now marks 16 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. Sources: Standard & Poor’s, as of January 31, 2024; Robert Shiller, Haver Analytics, as of October 17, 2023. Note: Due to data limitations for the Schiller P/E index, the valuation data is the same as last month’s update. 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 can be a good gauge of immediate risk. • When the change drops below zero over a 10-month or 200-day period, the market has tended to drop shortly thereafter. • On a 10-month basis, valuations rose 8.56% in September. Risk Level
  • 9. Source: Standard & Poor’s, Haver Analytics Note: Due to data limitations, the valuation data is the same as last month’s update. As of January 16, 2024. 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 have typically preceded a market drawdown. • Margin debt as a percentage of market capitalization increased on a year-over-year basis in December for the third consecutive month, with margin debt rising 8.7%. Risk Level
  • 11. Source: Standard & Poor’s, Haver Analytics As of January 31, 2024 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 can often signal further trouble ahead. • Technical factors supported major U.S. equity markets in January. All three major 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 February 9, 2024 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, it suggests that there is less complacency. • Periods of high valuations and low volatility have caused peaks in the index (e.g., 2000, 2006–2007, and 2017); market drawdowns occurred roughly one year after those peaks. • Market complacency fell slightly, with the index dropping from 1.53 in December to 1.51 in January. Source: Institute for Supply Management, Haver Analytics Risk Level
  • 15. Conclusion: Market Risks Remain • The continued rally for markets in January was welcome and helped start the year on the right foot. • The rise in market complacency is worth monitoring, as the high reading for the index signals potential concern. • 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