Bad News Can Be Good News... Until It's Not

The Weekend Edition is pulled from the daily Stansberry Digest.

The major U.S. indexes have snapped back higher...

As I wrote in the Digest this week, it looks like the sell-off of the past three months could go down in our memory as a garden-variety 10% "correction."

Specifically, stocks recently rebounded to their recent highs from October. A little more of a push higher and a year-end rally could be afoot, based on the analysis of technical traders like our Ten Stock Trader editor Greg Diamond.

But don't get it twisted. Risks for the economy in the longer term – namely, a recession – are still in the air.

So, with that in mind, I want to do three things today...

  1. Explain a juncture that I think the markets have arrived at... which has all the markings of a pre- or early-recession period.
  2. Share a reminder to "keep your eye on the ball" (your goals) and look past the short-term noise you may hear in the next few weeks or months.
  3. Point you in the direction of a trading strategy that can benefit from whatever direction the economy or stocks head next.

Away we go...

Investors believe "bad news" for the economy is "good news" for stocks today...

This concept has to do with our foils at the Federal Reserve and elsewhere in Washington. As we wrote in the Digest on Monday...

A Federal Reserve meeting wrapped up on Wednesday, where the monetary-policy string-pullers stood pat with interest rates. And a key Treasury announcement showed still-increasing long-term bond issuance, but less than was expected.

The latest monthly jobs report on Friday showed a slight uptick in the unemployment rate to 3.9% (from a low of 3.4% earlier this year), suggesting that there might not be much additional reason for the Fed to raise interest rates moving ahead.

So, that's good news – for now. Stocks are ripping...

Enough folks with enough money in the markets are happy to see a slightly rising unemployment rate and a continued easing of "official" inflation numbers.

They see those trends as signals that the almighty Fed will pause its interest-rate hikes until further notice, meaning it might be done raising rates to "fight" inflation.

Throughout history, a "Fed pause" has been bullish for stocks...

As Stansberry Research senior analyst Brett Eversole wrote earlier this year...

Over the past 40 years, stocks have a history of soaring after the Fed pauses rate hikes. And it means we could see the markets soar 20% over the next year...

You might not like the idea of jumping into the market when the Fed stops hiking rates.

After all, a rate-hike cycle happens for one reason... to cool down the economy. And by the time the Fed quits, the cooldown is in full effect.

Brett acknowledged that buying stocks in that kind of environment might seem foolish. That's not what history shows, though. As he wrote...

Buying when the Fed pauses rates is a smart bet. The table below shows what happened a year after each pause in the rate-hike cycle over the past four decades. Take a look...

We've seen six other rate-hike cycles in the past 40 years. In five of those cases, stocks were dramatically higher a year later. And the average gain was an impressive 19.5%.

The only losing year was after the Fed pause in 2000. And it was before the worst stretch of that bear market. Still, stocks only dropped 11% over the following year.

Basically, when the Fed pauses rate hikes, it means folks no longer expect the "cost of money" to keep rising. And the next expectation is that the Fed will cut rates. As Brett continued...

The forward-looking nature of the stock market really does explain what's going on. Just think about our current situation...

Stocks fell 25% peak-to-trough last year. During that time, unemployment fell... the worst of inflation passed us by... and the seemingly inevitable recession never materialized. Stocks lost a quarter of their value anyway. And that happened because the market had already priced in the likelihood that those bullish trends would reverse.

The stock market's forward-looking mechanism doesn't always do a perfect job. But most of the time, if folks are worried about something in the future, the market has already discounted prices based on that possibility.

That's why when the Fed pauses, stocks tend to soar. Even though the worst of the economic pain isn't over yet, it's already priced in... which puts a floor under expectations.

If the Fed is really done with its rate hikes – and it could be – be prepared for stocks to move higher. And, go ahead... Make hay while the sun shines. It might be some time before a recession "officially" arrives.

But as I'll explain now, it's getting close...

Keep your eye on the economic ball, too...

Eventually, "bad news" – like rising unemployment and a slowing economy – will be bad news for everyone, including the stock market.

This economic "cycle" may feel different than what we've seen in the past, given a pandemic, inflation, wars, politics, or whatever other specific factor. But I'm willing to bet it will end the same way it always does.

Take a look at this chart of the U.S. unemployment rate over the past 75 years. The gray areas are recessions...

There's a simple, time-tested, valuable pattern here... The unemployment rate is always at or near a record low right before a recession.


When unemployment is low, it typically means the economy is "hot." And then, counterintuitively to most people, the long arm of the Federal Reserve decides to slow the economy down to curb runaway inflation.

That's exactly what we've seen. The Fed raised rates from near zero to above 5% to pour water on the white-hot post-pandemic economy.

Essentially, the string-pullers at the Fed, Congress, and Treasury kicked the can of a "real" recession in 2020 further down the road... until right about now, if you ask me.

And now, unemployment is rising...

I have mentioned the importance of tracking the unemployment rate several times this year. That's because the institution that will actually "call" a recession – the National Bureau of Economic Research ("NBER") – by its own admission won't do so until the recession is well underway, or sometimes even over.

But one criterion for an "official" recession is a rising unemployment rate for a sustained period of time from a cycle low. That may sound like a mouthful, but it's simple to track.

The unemployment rate appears to have bottomed at 3.4% in April. It just checked in at 3.9% for October. That's a rise of 50 basis points.

Regular Digest readers know that means the economy may be on its way to meeting the "Sahm Rule"... when for three straight months, the unemployment rate averages 0.5 percentage points above its three-month average at cycle lows.

This indicator has found the start of each of the last four recessions correctly and early. It's named for Claudia Sahm, a former Fed economist (and, not coincidentally, a member of the NBER).

Our colleague Chris Igou in DailyWealth Trader wrote about this on Tuesday with great detail and a great visual. As Chris wrote...

a simple way to measure when unemployment trends are starting to rise. It simply draws a line in the sand for the starting point. And if you look at the past three decades, it's a darn good predictor of when a recession gets underway.

The gray bars in the chart below are actual recessions. And the blue line at the bottom is where this indicator triggers...

The latest reading is 0.33. That's not in recession territory yet. But notice that it's starting to move higher pretty quickly... just like it did in 1990, 2001, 2007, and 2020.

Each one of those cases was right at the start of a new recession. Also notice that we didn't get any fake runs higher in the past 30-plus years.

This indicator didn't trigger from 1993 through 2000. Nor did we see it in the early 2000s run between 2002 and 2006... or in the 2010s... or in 2022.

The point is, if unemployment ticks up a little more in the next month or two, the Sahm Rule indicator will likely trigger the start of our next recession. And it has a stellar track record of getting that timing right.

Now, it doesn't tell us how bad that recession will be or how long it will last. It just marks the starting point. It also shows that we are darn close today.

"But what about 4.9% GDP?" you might ask...

Certainly, third-quarter GDP growth of 4.9% annualized is not a sign of recession, right? Right. Not right now. But, counterintuitively, this is another indicator that a slowdown could be ahead. Because the economy is strong... until it's not.

Guess what GDP was in the third quarter of 2007 before the great financial crisis? Precisely 4.9% annualized.

Here's another bit of trivia: GDP growth in the second quarter of 2000 was above 5% annualized... even when the Nasdaq was in the early stages of its eventual 78% decline in the dot-com bust. That slide didn't end until 2002.

Frankly, this time around, I'm not sure if GDP will slow enough for the shot-callers at the NBER to call an "official" recession until well after it begins or is over. But that doesn't mean we won't see trouble in the economy and the stock market.

After all, no one officially said "recession is here" when GDP growth actually did go negative in early 2022 for two straight quarters (a technical recession). At that time, low unemployment meant the conditions didn't meet NBER's recession criteria.

The stock market sure acted like we were in a recession, though. The S&P 500 fell 25% before generally trending higher since last October.

Sorry to be the bearer of bad news, but history rhymes...

In summary, bad news can be good news – until it's not...

If the "Fed pause" sticks from here, inflation eases, and the economy cools, stocks could go higher. But then the economy will eventually get to the point where it needs help again (recession). And at that point, stock prices are likely to take a hit.

Alternatively, if inflation rebounds enough to where the Fed decides to raise rates again, that would likely send stock prices lower as well and make a recession more likely.

As we've shared before, stocks haven't bottomed until an average of 23.5 weeks after the start of a recession... Should unemployment keep going higher over the next two months, that would suggest a bottom for stocks in the middle of 2024.

So don't lose sight of the big picture when choosing your investments...

In the short term (the next few months), stocks could be due for a rally. In the long term (next year), a recession could still be ahead. Both things can be true.

So don't be surprised to see stocks rally in the weeks or months ahead – but don't forget the potential risks heading into next year, either. Take this as a reminder to manage risk appropriately for your own goals and timeline.

To this point...

When we think about "risk management," we quickly think about our colleague Greg Diamond. He constantly preaches the point to his Ten Stock Trader subscribers – and shares ways to make money in bullish or bearish moves in the market.

This is a critical flexible approach to consider right now, given the uncertainty of timing the economy and the stock market's next moves.

I haven't seen anyone else who called the "top" in stocks in early 2022 and the "bottom" in October...

On January 13, 2022, Greg predicted that a crash as bad as 2008 was coming. It began the day after. Along the way, you could have doubled your money six times with his recommendations and avoided huge losses.

In 2020, you could have doubled your money on 11 different trades leading up to the COVID-19 crash in March – and then booked a gain of more than 250% in six days as the market collapsed – using Greg's strategy.

It's the same approach he used back when he handled $900 million a day during his time as a trader on Wall Street.

Greg plans to go live with all the details of how it works on Tuesday, November 14, during a new free video event... And he'll share what his signals are telling him about the market's health in the coming months. You can sign up to attend right here.

Good investing,

Corey McLaughlin

Editor's note: Greg is predicting another huge move for the market – one he believes will shock most investors. And this time around, his analysis is backed up by AI-level software. This turning point could give you a shot to make multiple times your money... without buying a single stock. But you'll need to try something new – a strategy we rarely advertise.

Greg will explain how it works (and give away a free recommendation) on Tuesday, November 14 at 10 a.m. Eastern time. It's free to tune in, but you must RSVP ahead of time... Find out more details here.