Excerpt from fund manager John Hussman's weekly essay on the U.S. market (11/26/07):
Two weeks ago, for the first time since the 2001-2002 downturn, our measures again signaled an oncoming U.S. recession. This signal is based on four general conditions...
1: Widening credit spreads: An increase over the past 6 months in either the spread between commercial paper and 3-month Treasury yields, or between the Dow Corporate Bond Index yield and 10-year Treasury yields.
2: Moderate or flat yield curve: 10-year Treasury yield no more than 2.5% above 3-month Treasury yields (this doesn't create a strong risk of recession in and of itself).
3: Falling stock prices: S&P 500 below its level of 6 months earlier. Again, this is not terribly unusual by itself, which is why people say that market declines have called 11 of the past 6 recessions, but falling stock prices are very important as part of the broader syndrome.
4: Moderating ISM and employment growth: PMI in the low 50's or worse (below 54), coupled with either total nonfarm employment growth below 1.3% over the preceding year (this is a figure that Marty Zweig noted in a Barron's piece years ago), or an unemployment rate up 0.4% or more from its 12-month low...
As of Friday, the S&P 500 has lagged Treasury bills year-to-date. Longer-term, the S&P 500 has lagged Treasury bills for what is now nine full years. The recent bull market since 2002 was unusual, in that it started at the highest valuation of any bull market period in history. While 2003 presented reasonable conditions in which to accept risk, rich valuations also returned rather quickly.
The predictable consequence of this is that even a minimal 20% bear market decline from the bull market high would leave the total return on the S&P 500 since the end of 2003 at less than 5%... I expect that by the time that the current market cycle is completed, 2003 will be the only bull market year for which the market's returns (in excess of Treasury bills) will have been retained.