Recession and stock market declines in 2005?

Two recent articles, one by John Hussman and one by Jon Markman, have argued that the risk of recession in 2005 is greater than people realize.  They’re not alone.  Earlier this year, Jeremy Grantham predicted a tough year for the market in 2005 as the electoral cycle begins afresh.

Here’s a summary of the key points from Hussman and Markman:

In his September 20th Market Comment, John Hussman highlighted four indicators that appear immediately before or very shortly following the start of U.S recessions.  He argues that 3 of the 4 are currently flashing red.  In his words:

1) A flattening yield curve, with 10-year Treasury yields less than 2.5% above 3-month Treasury bill yields. Notice it is not necessary for the yield curve to actually invert. As of last week, the spread between these yields was under 2.5%.

2) Widening credit spreads, measured by either  the spread between 6-month commercial paper yields and 6-month Treasury yields, or between the yield on the Dow Jones Corporate Bond Index and the 10-year Treasury yield, compared with the same spread six months earlier. On this measure also, credit spreads have begun to widen, though not aggressively.

3) S&P 500 index below its level of 6 months earlier. This measure is currently moving back and forth between positive and negative comparisons, due to months of sideways action. Suffice it to say that even minor declines move the S&P to a negative 6-month return.

4) ISM Purchasing Managers Index below 50. This is now the final pillar to watch, after pulling back to a reading of 59 in the most recent report. The PMI has a mixed record when taken by itself, so most observers would probably take a benign view of a dip in the PMI here. For our part, that event would complete our simple four-indicator criterion for a recession warning. Though I would take such a warning in the context of broader, proprietary measures of market action, the likelihood is that a dip in the PMI below 50 would be sufficient evidence to confidently anticipate an oncoming recession.

Meanwhile, in a piece posted on 10/13 for his MSN SuperModels column, Jon Markman quotes a “research director of a major East Coast hedge fund who has supplied SuperModels readers with uncanny market-timing advice over the past four years