Financial Distress & Recession Indicators For Long-term Stock Market Investors

Recession Risk & Unemployment & Financial Distress Indicators

One of the most followed recession charts of the FRED database (Fed Reserve US Central bank) website is the 'Smoothed U.S. Recession Probabilities'. You can see the accuracy of this chart going way back to the 1970's

Smoothed U.S. Recession Probabilities (Fed Reserve chart)

Note: Recessions start AFTER the stock market tops and the end AFTER the stock market bottoms.

The MacroMicro home page has a recession probability percentage for the global economy and the US economy.

For a deep dive into recession risk and financial distress <<< CLICK HERE (new tab) >>>

Dow Theory – Recession/Bear Market Indicator

The Dow Jones Transportation Average (DJTA) is an average of the top 20 transportation stocks in the United States. The Dow Jones Transportation Average is closely watched to confirm the state of the U.S. economy. DJTA should confirm the trend of the Dow Jones Industrial Average (DJIA). If the DJIA is climbing while the DJTA is falling, it may mean economic weakness is ahead. (Goods are not being transported (DJTA) at the same rate at which they are being produced (DJIA), suggesting a decline in demand.) Analyst recommendations

Is DJT a sell (or neutral) whilst DJI is still a buy?

US Financial Conditions Index

The Chicago Fed index tracks a range of financial conditions to provide a measure of the overall health of economic conditions centred around credit, risk and leverage. The visual chart protruding above the flat zero line is a strong signal that the markets are in distress and indeed we see this happening during covid and the GFC 2008...

National Financial Conditions Index (NFCI)

US Credit Tightness

Related to the above we have the the following measure of Credit tightness by banks in the US which correlates very well with the onset of recessions as can be seen below.

There is a good correlation between tightening financial conditions and the grey shaded areas which are major recessions. Is the current level comparable to the 2000 DotCom crash or the 2008 GFC? ( Click the image below to see the latest version of this chart on the Federal Reserve website...)

Net Percentage of Domestic Banks Tightening Standards for Commercial and Industrial Loans to Large and Middle-Market Firms

The same chart on Trading Economics Net Percentage of Domestic Banks Tightening Standards for Commercial and Industrial Loans to Small Firms can be switched to the 25 year view to see the spikes coincide with the previous 2 crashes. Switch to the forecast tab to see the projected trend.

BANK TIGHTENING MEANS LESS BANK LOANS

When the banks tighten lending (blue line below spiking up), the number of loans (the redline below) starts to decline and this leads to recession (the grey shaded area below). As you can see, there is a strong correlation...

Another one from the brilliant Fed website below shows another strong correlation with the major 2000/2008 downturns. Demand for loans? ....

Net Percentage of Domestic Banks Reporting Stronger Demand for Commercial and Industrial Loans from Large and Middle-Market Firms

Credit Crunch Risk - Tightening Credit Conditions?

BANK TIGHTENING

One of the warning signs of trouble ahead is when banks begin turning off their credit taps through fear of adding poorly performing loans to their loan book. They 'tighten financial conditions'.

As can be seen in the image below, there is a good correlation between tightening financial conditions and the grey shaded areas which are major recessions. Is the current level comparable to the 2000 DotCom crash or the 2008 GFC? ( Click the image below to see the latest version of this chart on the Federal Reserve website...)

Credit Crunch Risk & Credit Spreads

The Chicago Fed’s National Financial Conditions Index (NFCI) releases a weekly update on U.S. financial conditions in money markets, debt and equity markets and the traditional “shadow” banking systems. As you can see from the Great Financial Crisis of 2008 (and to a lesser extent the 2000 crash) there should be a clear rise into the positive side of the graph if we are to see something similar happening now or in the future. (The same Trading Economics chart is also given below as the Chicago Fed chart doesn't always display properly)

Our friends over at Isabelnet.com are still cranking out loads of up to date charts to help us visualise various financial conditions relative to the economy...

Financial Conditions

The 10 year / 3 month yield curve

The market keeps a close watch on the 10year/2year Us Treasury yield curve but the 10year/3month correlates very accurately with the beginning of major downturns in stock markets when the yield curve inversion starts to come back up from a deep yield curve inversion as seen by the red shaded area below...

The ten year minus two year US Bond "Yield Curve" is widely watched as it it quite nicely negatively correlated with the direction of the SP500...

The same chart on a longer term basis shows the un-inversion of the yield curve ushering in significant market declines. Also shown is the Fed Reserve central bank rate to see how closely that correlates with the beginning of stock market declines.(Red shaded area 2001 "Dot Com" crash and 2008 "GFC" crash...)

Recession Indicators

The global recession probability on MacroMicro collates a number of recession indicator on a global scale to provide an global recession probability Index. (You might need to scroll through the "Indicators for Market Reversal for the Next 6 Months" section to see this chart. But also the homepage has teh Index value and a colour indication of it's severity)

The Duncan Leading Indicator is a respected and accurate leading indicator pointing to potential downturns anywhere between 1 to 4 years before the downturn materialises. It's more of an economic gauge of the longer term momentum trend in the economy.

The Conference Board Recession Indicator

Conference board LEI Index spikes down when recession is incoming….2024 looks more like 2008…

... but, Oil was a major difference between 2007 and now. If an escalation of the wars sparks an oil spike then risk increases for another 2008 style GFC: -

US Financial Conditions Index

National Financial Conditions Index (NFCI)

Stock Market Volatility (The US VIX)

When the VIX breaks north of 40 it's a sign that something is not right in the global financial system. The VIX usually oscillates between about 25 to 30 on the upper end and 10 to 15 at the lower end. These VIX lows often point to market pullbacks so we need to keep one eye on this chart.

If the VIX volatility index shoots up somewhere between 40 and 50 then see how on the longer timeframe chart below it marks major bottoms in the market. When the extreme high VIX reading starts to come back down is when the big opportunity of long term gains can be made by buying at extreme lows

The weekly VIX gives us a good indication of medium term market direction for the SP500. We track the trendlines on the VIX... VIX trending down = market trending up … and vice versa…

The VIX Crossover

When the VIX 50 day and 200 day MA are both moving up above about 15 to 17 then this is often a warning sign of trouble ahead. Greater volatility is when markets can sell off and slide to the downside ...

VXV:VIX ratio above 1.2 correlates quite nicely with market tops and lows below 1 with market bottoms...

Volatility Indicators

The MOVE index tracks the volatility in the bond markets. In tha long term chart below, we can see that there is a strong correlation between the MOVE index and the SP500. When bond market volatility increases then it is likely that the SP500 will start moving down. Bond market volatility is associated with interest rate volatility. So when you see ineterest rates chopping and changing and moving up or down in a short space of time, it's bad sign for the stock market. In the chart below the MOVE index is inverted to make the correlation clearer: -

Bond/Credit Market Spreads

The difference between riskier but high yielding junk bonds and 'risk-free' government bonds is highly correlated with declines in the stock market.

The Bank of America High Yield Index Option Spread is another one popular credit spread chart that is often quoted as a measure of financial stress in financial markets. the DotCom crash and the GFC crash show clear spikes but the situation currently at the time of writing really shows no signs of distress whatsoever...

ARE HIGH YIELD CORPORATE DEBT SPREADS SIGNALLING PANIC?

If High Yield Corporate debt costs (spreads) spike, it is a sign of panic in the debt markets and potentially systemic default risk of some form. The two links below for the US and European debt markets show these spikes for the Dot Com crash at the start of the century and the Great Financial Crisis of 2008 when you switch to the 'Max' timeline view.

The Bank of America High Yield Spreads chart below highlights the rise from low levels that preceeded the start of the DotCom crash, the GFC 2007 crash, the equities downturns of 2015/16/18 and the 2022 inflation inspired downturn. A future downturn would see a similar pattern emerging from a low position to an elevated one...

BONDS TO CASH SPREAD INDICATOR

Another indicator to add to our arsenal is the spread between BBB rated bonds and what is essentially cash. This is only the 6th time in stock market history this level has been reached. (See the lower red circles on the graph below). Like the recent yield curve inversion, this indicator has exceeded than what was seen in 2007 before the Great Financial Crisis...

BOND DEFAULT RATES - A RECESSION/BEAR MARKET INDICATOR

The New York fed recent launched the Corporate Bond Market Distress Index (CMDI) to provide a quantified measure of the health of the corporate bond market. This article provides a further explanation but you can switch the link below to the 'Overview' tab also to get an explanation.

Corporate Bond Market Distress Index (CMDI)

Bad Loans with Rising Bank Tightening & Unemployment Claims

Highlighted on the chart below in red is the rise in delinquencies ('All Loans') leading into major financial crises. Falls in inflation can precede a drop in delinquencies and resolution of the financial crisis. In 2024 however we are not seeing the drop in delinquencies but the big question is, ofcourse, are the delinquencies going to keep rising into a new financial crisis?

As can be seen below, the delinquency rate rises (the red line) before the Dot-Com and GFC recessions (grey areas) are accompanied by tightening financial conditions (the blue line)... (Click on the image to see the latest delinquency chart)

In order to back up the chart rise in delinquencies (red line) leading to recessions, we are looking for a rise in unemployment claims leading into a recession... (Click on the image to see the latest chart)

More Employment Related Charts to Watch...

The charts below reveal how Unemployment is accompanied by other co-factors in a declining market and recessions. The first is particularly interesting showing a threshold type low that preceded the 2007 recession by 14 months which has now just been reached once again in 2025. Recession in 2026?

It's worth keeping one eye on the Invesco Senior Loans ETF (Leveraged Loans) ...

Another interesting financial distress indicator for the US economy is the auto-loans delinquency rate. As you can see below, these trend up or spike before a financial crash...

When corporate profits head down whilst unemployment trends up, it's another warning sign that the economy is struggling...

... other distress signals shown against unemployment and/or social security claims for unemployment : -

average hourly earnings
credit card delinquencies

The chart above shows credit card loan delinquencies but the delinquency rate on ALL loans shows a clear relationship with an upturned slope and recessions...

Secular declines in consumer sentiment is a secular sign of financial distress leading to secular declines in the stock market...

The 10 year / 3 month yield curve

As for small caps, the best time to invest in this asset class is when the central bank(s) reduce the central rate from a high point to a low point, which is generally after something broke in the financial markets and they need to take drastic action...

Yields & Yield Curve Inversion

Since 1950, all major US recessions (and there have been 9 of them) were preceded by an inversion of a specific segment of the ‘yield curve’. Click here to see the evidence for this in black and white.
An inversion of the spread between 2 year and 10 year Treasury bonds happens when two year Treasury's yield more than their 10 year counterparts.
It can take up to 34 months for the recession to hit after the inversion. (This Business Insider link (opens new tab) explains this in more detail.)
See our dedicated Yield Curve Inversion page.
VERDICT as of NOV 2024: BEARISH

Bankruptcies

In an economic downturn, bankruptcy levels spike and so tracking bankruptcies in the US will furnish us with another clue as to where the economy is heading. Credit crunches lead to bankruptcies. US corporate bankruptcies are up 43% from 2019.

Bankruptcy Filings in the US surged to extreme levels in 2023. These levels were similar to those seen at the GFC in 2008 and the 2020 Covid Pandemic...

Falling Demand (Imports) with Rising Unemployment

The 3 main pre-covid US (and global) market crashes were accompanied by the Imports line crossing below zero and the Unemployment line starting a steeper ascent from a low position on the "Change from a Year ago" measure...

LATEST ISABEL RECESSION INDICATOR NEWS

Recession Indicators

The MacroMicro global macro dashboard uses it's own Global recession indicator. Check out the global recession indicator chart which has gotten its calls or recession correct in the past.

The GDP based recession indicator below from the good old Federal Reserve claims to be an improvement as compared to the NBER Index which it claims is based on subjective assessment of indicators and is heavily lagged. As opposed the this GDP based indictor (link below) which uses the previous GDP quarter and is not revised up or down. It looks to be a pretty accurate indicator so definitely one to keep an eye on...