The S&P 500 has powered to fresh all-time highs in recent weeks, fueled by solid economic data, strong corporate earnings, and positive market momentum. However, concerning recession signals for 2024 are flashing warnings of major turbulence ahead.
This article analyzes the likelihood of a 2024 economic downturn, and forecasts the market impact if a recession unfolds. The base case predicts an 18% S&P 500 peak-to-trough correction by end-2024 even in a mild recession outcome. With risks skewed to the downside despite any remaining near term buoyancy, caution is advised for equity investors at current elevated levels.
Smooth Sailing Today, But Clouds Gathering on Horizon
Bolstered by upbeat consumer spending, actual Q3 GDP accelerated to a brisk 5.2% annualized clip, overcoming prior recession fears. Meanwhile, inflation has moderated substantially from 40-year highs, and employment remains historically strong.
With growth solid, inflation cooling, jobs plentiful, and corporate profits churning higher, investor sentiment has turned outright giddy. The S&P 500 has responded in kind, up over 15% year-to-date. Heady positive momentum could well propel additional near term gains.
However, the old adage rings true that the market climbs a wall of worry. With much economic news still favorable today, market optimism likely nears a cyclical peak. Historically, the best time for caution is when everything looks rosiest.
As the saying goes, we climb the wall of worry, and descend on a rope of hope. Sentiment and growth often crest immediately prior to market setbacks.
Yield Curve Screams High Recession Odds in 2024
Peering over the horizon, warning sirens are sounding from asset markets closely attuned to economic shifts. Specifically, the bond market’s yield curve has proven a highly reliable recession indicator historically.
When short-term rates climb above longer-dated yields, forming an “inverted” yield curve, recessions have unfailingly followed in modern times. On average, past inversions foreshadowed economic downturns by around 24 months.
Crucially, today’s yield curve inverted earlier this year and remains negatively sloped. The 24-month average lead time points to intensifying recession impacts in the second half of 2024 and beyond.
Mild Recession Base Case, But Still 18% Downside Risk
Not all recessions are created equal, however. The depth of economic and market drawdowns has varied dramatically between past episodes.
Given still-resilient recent data, this article assumes a relatively shallow contraction as the base case for 2024. But even mild recessions have compressed corporate earnings and market valuations historically.
Specifically, average S&P 500 earnings per share (EPS) has dropped 16.4% across past downturns. Its forward price-to-earnings (P/E) multiple has compressed by 26% as well.
But with recession odds still subject to Fed policy shifts and geopolitics, a tempered earnings and multiple reset is foreseeable. Factoring in an unprecedented level of uncertainty clouding the outlook, this analysis forecasts flat S&P 500 EPS of $220 in a 2024 mild recession, alongside a 10% P/E compression from today’s elevated levels.
That combination translates to a forward S&P 500 level of 3754 by end-2024, 18% below current all-time highs around 4600.
Upside Risk If No Recession, But Still Overvalued
The obvious alternative scenario is continued economic expansion, avoiding recession altogether. Aggressive Fed tightening and/or easing geopolitical tensions could bolster the odds.
In that case, the consensus 11% S&P 500 EPS growth forecast for 2024 would likely be achievable. Avoiding a downturn catalyst would also enable an elevated P/E ratio to persist.
Under those assumptions, today’s S&P 500 valuation around 4600 appears roughly fair. However, with the index already historically overstretched, further upside looks limited even without recession.
Reward Still Lacks Appeal
In totality, recession risks look increasingly palpable, flagged by the proven bond market barometer. At the same time, prevailing S&P 500 overvaluation offers scant upside without a downturn anyway.
That skewed risk-reward ratio keeps the market rating no better than HOLD today. While more resilient data and sentiment could stoke additional near term euphoria, substantial downside potential still lurks past that.
With fear of missing out running hot, the prudent course still appears reacting to tangible deterioration, rather than guessing at further upside. If key indicators like employment and retail sales crack, hedging or reducing equity exposure would grow warranted.
Until such concrete changes emerge, traders should avoid letting hope or panic sway decisions unduly. But staying alert and responsive to shifting conditions remains key to navigating the apparent storm clouds massing on 2024’s horizon.
