In a matter of weeks, the market has shifted from post-election bullishness, to pricing in a slowdown, to even bracing for a potential recession.
As of the market's close on April 8, the S&P 500® had fallen about 19% from its most-recent all-time high, which it struck only in February. That magnitude of decline is just shy of the bear market threshold. While the market recovered some of that lost ground with its bounce on April 9, where it goes next could be anyone's guess.
Whether this becomes a confirmed bear market remains to be seen. There have been several 20% drawdowns over the years which quickly recovered (think 1998, 2011, and 2018). This could well be one of them, but for now the knife is falling fast and we have not yet reached the kind of oversold extremes that in the past have created high-conviction buy signals.
At the same time, market leadership has been rotating away from the “Magnificent 7” group of US stocks, and toward international stocks. That makes the stakes higher than usual. Is a tectonic shift taking place?
Anatomy of the drawdown
Declines of this magnitude happen every few years, and the market has historically always recovered—often quickly and sometimes slowly. The last big drawdown was in 2022 (−28%), the one before that was in 2020 (−35%), and the one before that in 2018 (−20%).
The recent drawdown has been fast and fierce. The good news is that compared with most historical drawdowns, the market has already come close to the bottom of the range in terms of speed and magnitude, as the chart below shows. That suggests the market could find some balance in the weeks ahead.
Is the market oversold yet?
US stocks have looked to be moderately oversold, but not remarkably so. The percentage of stocks trading above their 200-day moving average was down to 23% as of the start of the week. The percentage of stocks trading above their 50-day moving average was down to 13%.
Both of these figures are on par with what tends to happen in a decent-sized correction. But they’re not at levels typically seen during bear-market extremes (when these metrics may fall into the single digits).
Another way to measure this is with breadth data. After last week’s selling, some 29% of stocks in the S&P 500 had reached 52-week lows. Again, that’s in line with other medium-sized corrections, but well shy of the “close-your-eyes-and-buy” levels produced at generational extremes. The COVID crash in 2020 produced one of those rare signals, and it proved to be a good one.
Growth scares and recessions
Now that the market has repriced from a mere slowdown to something worse, such as recession, the next question is whether that recession is coming and how bad one could be.
While the market has dipped a toe into bear-market territory on an intra-day basis this week, it has not yet closed in bear territory, which is typically considered the more-important threshold. Should we find ourselves in a confirmed bear, history tells us that the median non-recession bear market has produced a total decline of 22% (which is not far from the peak-to-trough decline already experienced), and the median recessionary bear market has seen a peak-to-trough decline of 35%.
The difference between a more benign recession and a financial crisis has often been leverage. On the surface, I don’t see many instances of excessive leverage the likes of which we experienced in the lead-up to the 2008 to 2009 financial crisis. The Fed is not tightening, the banks have continued to be well-capitalized, and there is no obvious consumer or corporate debt bubble that I can see.
Earnings estimates likely to decline
The price action has been too fast and furious to affect earnings estimates much thus far, but that will likely change as first-quarter earnings season gets further underway. As of the start of the week, analysts were still expecting earnings growth of 9% for the S&P 500 in 2025. But if the declining gross domestic product (GDP) estimates are any guide, that number is likely to come down in the coming weeks.
Declines in valuations such as price-earnings ratios (PEs) have been putting downward pressure on stock prices, as I suspected they would this year. The S&P’s PE ratio is now down 10% over the past year. Starting points matter, and the market has entered this recent drawdown from a point of relatively rich valuations.
The juxtaposition of growing earnings and falling valuations is reminiscent of the 20% stock-market decline in late 2018. That cycle recovered very quickly, thanks to a quick Fed pivot. But the Fed might be less inclined to jump in with rate cuts this time around, given that inflation has continued to run above the Fed’s target, and given the potential for further inflationary pressures from the recent trade-policy changes.
Clues from the bond market
Seasoned investors often watch the bond market for clues in moments of stock-market stress. The bond market has often been more prescient in predicting economic trouble and can provide a less noisy signal than the stock market.
One key metric to watch will be credit spreads, which measure the difference in yield between bonds that have credit risk (such as investment-grade corporate bonds or high-yield corporate bonds), and bonds that do not have credit risk (i.e., US Treasurys). When these spreads increase, it indicates bond investors are becoming more worried about future defaults, and can imply economic trouble ahead.
As of this week, credit spreads have not yet been confirming a recession scenario, but they have been heading in that direction. Investment-grade credit spreads have increased by 0.40 of a percentage point, but remain quite modest by historical standards. High-yield credit spreads have seen a bigger increase, but at a recent 4.68 percentage points they are still not too far from their historical mean.
As with other signals, so far this is indicating a garden-variety drawdown, but it’s worth continuing to watch.
The US dollar
One of the more unsettling features of the market’s sudden derating has been the weakness in the US dollar. Typically, or at least since the 2008 to 2009 financial crisis, periods of market stress have led to rallies in the dollar as global investors have sought safety, and as leveraged investors have to meet margin calls. But in recent weeks, the decline in stocks has been accompanied by a falling dollar.
It’s far too soon to make any pronouncements about the future of the world’s longtime dominant reserve currency. But given the profound implications it could have for investment approaches, this will be another key indicator to watch in the weeks to come.
