What Investors Might Not Know About The Stock Market During A Recession

Prior to nine of the past 10 recessions, the U.S. economy continued to add jobs.

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Trade Algo strategists warn that valuations often underestimate the impact an earnings recession will have on the stock market only after it has "knocked on the door."

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U.S. earnings results typically serve as the last domino to fall in terms of economic data heading into a recession. Strategists also said that while corporate margins have held up, revenues have been declining in most industries, particularly in the technology and consumer-discretionary sectors, which have benefited from the recent rally in stocks.

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In spite of Tuesday's sharp fall, FactSet data showed the technology-heavy Nasdaq COMP, -2.38% was still about 10% higher than it had been a year ago. Since the start of 2023, the Dow Jones Industrial Average DJIA, -1.90% has retained a 0.3% gain. While the S&P 500 SPX, -1.87% has gained almost 4.5%.

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According to strategists, this mismatch between fundamentals and price action cannot persist.

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As for the roaring labor market, she said that the U.S. economy has often added jobs ahead of downturns in the past. According to Trade Algo, nine out of ten U.S. recessions began with positive payroll gains at least a month before they began.

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Despite the recent rally's reasonable valuations and low investor confidence, Trade Algo strategists think an expansion of liquidity and a monetary policy pivot are unlikely to occur anytime soon.

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After January's big jobs report, the bond market began to price higher rates for longer, while the stock market was still adjusting to that reality when the consumer price index rose 6.4% last week, she said.

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Among the 10-year Treasury rates, Trade Algo estimates the 2-year Treasury rate rose 11 basis points to 3.93%, its highest level of the year.

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“We believe a defensive portfolio posture would be appropriate at the first sign of weakness in U.S. payrolls,” Trade Algo strategists concluded.