- There are three tell-tale signs that an economic recession is imminent, according to Bank of America.
- The bank looked at 150 years of recession history and warned that 2 signals have already flashed.
- "The stock market is ignoring the risk," Bank of America said.
Over the past 150 years of recession history, there have been three clear signals that flash right before an economic downturn is about to hit.
According to Bank of America, two of those three signals have already flashed, and it could result in a disastrous outcome for the stock market.
"The stock market is ignoring the risk," Bank of America said, highlighting that risk-on consumer cyclical stocks have been outperforming defensive stocks in recent months. Defensive stocks typically outperform during economic declines, and with one potentially right around the corner, it's time for investors to wake up.
These are the three signals investors should monitor for an incoming recession, including the two that already flashed, according to Bank of America, which analyzed 30 US recessions since the late 1800s.
1. Yield curve steepening (check)
"Yield curve steepening after inversion tends to precede big lows in the stock market," Bank of America said. "Get defensive as the yield curve steepens."
The yield curve measures the difference between short-term and long-term US Treasury rates. Currently, short-term rates are yielding more than their long-term counterparts, which is not typical. Investors usually earn more interest when they lend out their money for longer periods of time.
According to BofA, the yield curve inversion is a solid signal that a recession is imminent. Since 1921, eight out of ten yield curve inversions have preceded recessionary bear markets. And when the yield curve steepens and uninverts, it's typically a sign the recession is just months away.
The 2-year and 10-year yield curve inversion has steepened from negative 1.07% at its peak to negative 0.54% today.
2. Tighter credit conditions (check)
"The Fed's Senior Loan Officer Opinion Survey has tracked bank willingness to lend since the 1960s. It is flashing warning signs. Lending standards have never gotten this tight without leading to or coinciding with a recession. Credit conditions typically turn negative about a year before a buyable low in the market. December 2022 saw the first credit tightening since Covid, and conditions have worsened since then," BofA said.
And credit conditions could tighten even further as the US banking system continues to reel from the collapse of Silicon Valley Bank.
3. The Fed forced to cut interest rates (not yet)
"Several Fed cuts to start easing policy have been unabashedly bearish signals. Recessionary bear markets typically see 25% more downside after the Fed's first cut," BofA said, recommending that investors "raise cash on the first Fed cut."
The CME FedWatch Tool shows that investors currently expect one more interest rate hike from the Fed at its May FOMC meeting, followed by a pause in June and a cut in July. The market is currently pricing in about 100 basis points of interest rate cuts by the end of the year.