Monthly Market Risk Update: June 2024 [SlideShare]

Markets rallied in May, with all three major U.S. equity indices up for the month, said Sam Millette, director of fixed income, in his latest Market Risk Update.

For more market updates, subscribe to The Independent Market Observer at https://blog.commonwealth.com/independent-market-observer.

1. Monthly Market Risk Update June 2024

2. Recession Risk Recessions are strongly associated with market drawdowns; 8 of 10 bear markets have occurred during recessions. According to the National Bureau of Economic Research, the last recession began in February 2020, at the start of the pandemic, and ended soon thereafter. The economic expansion continued in May, with continued hiring growth serving as a highlight. The primary risks are a deeper slowdown in growth and tighter monetary policy from the Fed. Source: Institute for Supply Management, Haver Analytics Risk Level

3. Economic Shock Risk A major systemic risk factor is the price of money, otherwise known as interest rates. Interest rates have driven the economy and financial markets; historically, they’ve also played a key role in market downturns. So, let’s take a closer look at the yield curve. Source: Institute for Supply Management, Haver Analytics

4. Spread Between 10-Year U.S. Treasury and 3-Month U.S. Treasury Yield Curve (10-Year Minus 3-Month Treasury Rates) Source: Haver Analytics As of May 31, 2024 Risk Level

5. Yield Curve (10-Year Minus 3-Month Treasury Rates) continued The yield curve inversion widened modestly in May. The 3-month yield ended the month unchanged at 5.46%. The 10-year yield fell from 4.69% to 4.51%. This now marks 20 consecutive months with an inverted 3-month 10-year yield curve. This doesn’t guarantee that the economy will enter a recession, but this widely monitored signal could indicate further slowdowns. Risk Level

6. Market Risk Beyond the economy, we can also learn quite a bit by examining the market itself. For our purposes, two things are important: To recognize which factors signal high risk To try to determine when those factors signal that the risk has become an immediate concern Here, we’ll review valuations , margin debt , technical factors , and market complacency .

7. Sources: Standard & Poor’s, Robert Shiller/Haver Analytics, as of May 31, 2024 The Shiller P/E ratio (Shiller Cyclically Adjusted Price-to-Earnings Ratio) is defined as price divided by the average of 10 years of earnings (moving average), adjusted for inflation. Stock Price Index: Standard & Poor’s 500 Composite EOP, 1941-43=10 Valuations: 10-Month Change in Shiller P/E Shiller Cyclically Adjusted S&P Price-to-Earnings Ratio 10-Month % Change Risk Level

8. Valuations: 10-Month Change in Shiller P/E continued Looking at the 10-month change in the Shiller cyclically adjusted price-to-earnings ratio can be a good gauge of immediate risk. When the change drops below zero over a 10-month or 200-day period, the market has tended to drop shortly thereafter. On a 10-month basis, valuations rose by 12.48% in June, up from 9.52% in May. Risk Level

9. Source: Standard & Poor’s, Haver Analytics As of June 14, 2024 Stock Price Index: Standard & Poor’s 500 Composite EOP, 1941-43=10 Margin Debt as % of NYSE Market Capitalization FINRA Margin Debt as % of NYSE Market Capitalization % Change Year-to-Year Risk Level

10. Margin Debt as % of NYSE Market Capitalization continued Spikes in debt levels have typically preceded a market drawdown. Margin debt as a percentage of market capitalization increased on a year-over-year basis in April for the seventh consecutive month, with margin debt rising 10.18%. Risk Level

11. Source: Standard & Poor’s, Haver Analytics As of May 31, 2024 Stock Price Index: Standard & Poor’s 500 Composite EOP, 1941-43=10 Technical Factors: 200-Day and 400-Day Moving Averages S&P 10-Month (200-Day) Moving Average S&P 20-Month (400-Day) Moving Average Risk Level

12. Technical Factors: 200-Day and 400-Day Moving Averages continued We start to pay attention when a market breaks through its 200-day average; a breakthrough of the 400-day average can often signal further trouble ahead. Technical factors supported major U.S. equity markets in May. All three major indices ended the month above their respective 200-day moving averages. Risk Level

13. S&P 500 Forward P/E Divided by VIX Market Complacency: S&P 500 Forward P/E Divided by VIX Source: Haver Analytics, FactSet As of June 14, 2024 Risk Level

14. Market Complacency: S&P 500 Forward P/E Divided by VIX continued Often, high valuations (forward P/E) signal investors are confident and potentially complacent. When volatility (VIX) is high, it suggests that there is less complacency. Periods of high valuations and low volatility have caused peaks in the index (e.g., 2000, 2006–2007, and 2017); market drawdowns occurred roughly one year after those peaks. Market complacency surged during the month, with the index rising from 1.28 in April to 1.61 in May. Source: Institute for Supply Management, Haver Analytics Risk Level

15. Conclusion : Market Risks Rising Despite the rebound in May, markets face real risks as we head into the summer months. Rising valuations and market complacency are potentially worrying and indicate risks for investors. As we saw in April, investors remain concerned about inflation and interest rates, and we may see future sell-offs if inflation stays high in the second half of the year . Source: Institute for Supply Management, Haver Analytics Risk Level

16. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged, and investors cannot invest directly in an index. The information contained herein is provided for informational purposes only and is based upon sources believed to be reliable. No guarantee is made as to the completeness or accuracy of the information. Disclosure