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January 12, 2023

Historic bear markets, Nowcasting, and a lucky warm winter in Europe

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Nicolas Tremel
Arnaud Lieugaut
Karl-Philip Nilsson
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The most down days for equities since the 1970s

“Worst since 2008” is an oft-used descriptor in the financial world. It might not surprise the reader to learn that, indeed, in 2022 the S&P 500 posted its steepest decline (19.4 percent) since the year of the global financial crisis. 

If we measure the bear market by the number of down days, we have a stronger superlative, as our chart shows. 

As markets digested surging inflation, a tighter tightening cycle than expected, and Russia’s war on Ukraine, the benchmark US stock index had 143 negative trading days in 2022. That’s the most since 1974 – and matches the Great Depression year of 1931.

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The World Bank is more pessimistic

The World Bank cut its global economic growth forecast this week and is expecting a more stagnant 2023 as countries tighten monetary policy. As our table shows, the international institution now foresees GDP will increase just 1.7 percent, down from the 3 percent pace it projected in July. (It’s also not ruling out an outright recession.)

The World Bank became only mildly more pessimistic for 2024, perhaps indicating faith in central bankers’ attempt to engineer a soft landing. 

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Nowcasting US GDP with Macrobond

Understanding what’s happening in the economy in real time is important. Nowcast models aim to “predict” the present, given there is a lag before data becomes available, and keep investors ahead of the curve. 

Macrobond provides customers with well-known Nowcasts from institutions such as the OECD and the Atlanta Fed. But why not construct your own? 

The following chart was generated from a template we constructed. It gathers time series ranging from industrial production and the labour market to business surveys and financial data. It uses built-in principal component analysis (PCA), together with a vector auto regression (VAR), to estimate real-time GDP. 

Macrobond users can change any of these input variables to create their own Nowcast.

(At the moment, our template is Nowcasting a growth slowdown for the US that stops short of a contraction.)

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Growing and shrinking slices of the Eurozone inflation pie

Macrobond now offers pie charts (requires version 1.26). We have applied this functionality to analyse trends for various components of inflation in the eurozone.

Inflation remains elevated overall, posting a 9.2 percent year-on-year gain in December, though that was lower than expected and marked a slowdown for a second consecutive month.

This pie chart is a visualisation of hot and cold categories that make up the Harmonised Index of Consumer Prices (HICP). Prices for some line items in a household budget are rising ever more rapidly, while other spending categories are leveling off. (Here’s a link to a recent heatmap of inflation hotspots, as organised by sector.)

More than 46 percent of HICP components are posting price increases that are below 5 percent and decreasing (the green – and largest – part of the pie), bolstering the argument that inflation is tapering and might result in a less hawkish ECB. But the red tier – components where inflation is above 5 percent and increasing – is almost as large.

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Warm winter and preparation help Europe avoid a natural gas crisis

Amid concern that Russia would weaponise gas supplies to Europe, the EU set targets for member states to fill their storage capacity to at least 80 percent by November. (Last year, we published a chart showing how Russian gas shipments were dwindling). Member states turned to the LNG market; some observers were fearful that shortages and rationing could result.

As a result of the EU’s caution and what has turned out to be an unusually warm European winter, gas storage is still above that target level in a month normally known for peak energy demand. As the first chart shows, storage levels were about 83 percent in December, higher than they were at the same point in both 2021-22 and the generally chillier 2020-21.

The second chart, tracking weekly changes to the storage levels over those winters, shows that for part of December 2022, gas storage levels actually increased.

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German trade balance remains under pressure on expensive energy

This chart of Germany’s trade balance shows the importance of expensive energy imports to the world’s no. 3 exporting nation. 

The trade balance weakened in October but remained in positive territory. Key German export markets were hit by inflation and supply-chain issues. 

China was still implementing zero-Covid, disrupting trade with another key partner. As the strictness of that policy is unwound, Germany’s non-energy trade balance has potential to improve, but it still faces the possibility of a US-led global recession.

The trade deficit in energy is slowly shrinking, but remains strongly negative as the nation replaces Russian gas with pricier LNG.

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Hiring is a vicious circle in the tight US labour market

The post-pandemic US labour market has stayed robust in the face of a historic tightening cycle, with an unemployment rate of just 3.5 percent as of December. 

The following “circle” tracks employers’ search for workers – and how different the trend has been since 2021. It uses CEO surveys from the Conference Board to plot quarterly data points.

The X axis shows the percentage of CEOs that think they will expand their workforce more than 3 percent. The Y axis shows the percentage who feel it is difficult to attract qualified people. 

Both figures soared compared with the pre-2021 period, but have roughly returned to historic averages recently. The resilience of the labour market will be tested in 2023.

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Historic bear markets were tougher than this one

As we showed in our first chart, last year was tough for US stocks. But compared with past slumps, the S&P 500’s decline is not especially punishing – yet. Will a US recession make this bear market more historic? 

The chart below graphs the last 60 years of bear markets in terms of both depth and time. Stock markets that peaked in 1956, 1966 and 1980 fell more than 20 percent thereafter, exceeding the 19.4 percent drop in the current bear market. 

After the peak of 1968, the S&P 500 posted a decline of more than 30 percent, as it did after the 1987 and 2020 crashes. The bear markets beginning in 1973 and 2000 approached 50 percent. 

Unsurprisingly, the most extreme move was during the global financial crisis: the S&P 500 fell more than 50 percent during the 15-month bear market that started in 2007.

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130 years of history also suggest a recession is not priced in to US stocks

Many observers expect a recession this year as leading indicators in manufacturing and services flash red. Both CEO and small-business confidence are near record lows. But is a recession priced into the stock market?

A historic valuation barometer that may shed some light is the Shiller price-earnings ratio, which can be measured back to 1893. Our chart graphs this historic ratio against a smoothed-out, 12-year moving average. 

One might expect a discount versus the long-term average if we were going into recession. But the latest figure shows a P/E ratio of 28 – a small valuation premium relative to the 12-year average.

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Home transactions plunge as Fed hikes stamp on the brakes

As expected, the Fed’s rapid tightening is having a strong effect on the US housing market. (We considered this from multiple angles in October.

The effect on transaction volumes has been particularly notable.

This chart tracks home sales in different Fed tightening cycles. Transactions have taken just six months to drop 30 percent – more quickly than in any other cycle over the past 50 years.  

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