In the past two months, the amount of volatility in the
financial market has increased significantly. The VIX index which measures the
amount of volatility in the market has increased to more than 20. These are the
highest levels since early this year. Even without the index, the daily
movements in the markets have become more extreme. These days, it is not
uncommon for the Dow to gain 500 points at the open and lose it all within the
trading day. The chart below shows the recent performance of the S&P, Dow,
and Nasdaq in the past one year.
This volatility has led many in Wall Street to start
preparing for a recession in the coming year. They are guided by a number of
pointers that have led to a raised possibility about recession. First, the Fed
is raising interest rates. Most of the recent recessions have happened at a
time when the Fed is hiking. Second, the yield curve is nearing the inversion. As
shown below, an inverted yield curve has predicted the past seven recessions.
Third, there has been a record level of mergers and
acquisitions. These acquisitions have been fueled by the record low interest
rates and the benefits of the tax relief. In the past, recessions have come at
a period of increased M&A activities.
Fourth, the level of corporate debt has continued to
increase in the United States. Again, this was mostly because of the low
interest rates. Surprisingly, a good amount of the borrowed money has gone to
shareholders through dividends and buybacks. For example, a recent report found
that the amount of corporate debt in the oil and gas industry has gone up to
the highest level. This has happened as the companies increase their spending
in the shale industry. There are other indicators such as the lowered
confidence levels, weak business surveys, falling home prices, and weaker jobs
data.
With all these indications, a number of Wall Street banks
have started warning about the chances of a recession in the coming year. JP
Morgan has raised the chances of a recession to 35%. Other banks that are
warning their customers are Bank of America and Citi. However, it is important
to note that predicting when a recession will happen is a relatively
complicated thing.
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