(Bloomberg Opinion) -- As a longtime market observer, what I find most interesting about the latest correction in equities has the feeling of inevitability that it will turn into something worse. It wasn't this way in late January, when everyone wanted to buy that dip. It certainly wasn't this way in 2007, when the magnitude of the recession was grossly underestimated.
Even the Federal Reserve is getting into the pessimism. Chairman Jerome Powell signaled last week that a pause in interest-rate hikes might be forthcoming. What's interesting about that is Powell surely knew that such a reference might be interpreted as bowing to pressure from President Donald Trump and yet he did it anyway. In essence, he risked the perception of the Fed's independence probably because he knows the economic data is worsening.
Just about everyone I talk to in the capital markets, including erstwhile bulls, acknowledges that things are slowing down. Yes, the Institute for Supply Management's monthly manufacturing index released earlier this week was strong, but jobless claims are ticking up and I am hearing anecdotal reports of a wide range of businesses slowing down. Even my own business is slowing. Anecdotes aside, oil has crashed, home builder stocks have been crushed, and the largest tech stocks in the world have taken a haircut. If we get a recession from this, it will be a very well-telegraphed recession. Everyone knows it is coming.
A recession is nothing to fear. We have lost sight of the fact that a recession has cleansing properties, helping to right the wrong of the billions of dollars allocated to bad businesses while getting people refocused on investing in profitable enterprises. Stock market bears are so disliked because it seems as though they actually desire a recession and for people to get hurt financially. In a way, they are rooting for a recession because they know that the down part of the cycle is necessary.
There are signs that capital has been incorrectly allocated. In just in the span of a year, there have been three separate bubbles: one in bitcoin, one in cannabis and one in the FAANG group of stocks: Facebook, Apple, Amazon.com, Netflix and Google-parent Alphabet. This is uncommon. I begged the Fed to take the punch bowl away, and it eventually did, and now yields of around 2.5 percent on risk-free money are enough to get people rethinking their allocation to risk.
Yet, I wonder if it is possible to have a recession when so many people expect one. The worst recessions are the ones that people don't see coming. In 2011, during the European debt crisis, most people were predicting financial markets Armageddon. It ended up being a smallish bear market, with the S&P 500 Index down about 21 percent on an intraday basis between July and October of that year. It actually sparked a huge bull market in the very asset class that people were worried about: European sovereign debt. We may one day have a reprise of that crisis, but if you succumbed to the panic at the time, it was a missed opportunity.
But just the other day, the front end of the U.S. Treasury yield curve inverted, with two- and three-year note yields rising above five-year note yields. Everyone knows that inverted yield curves are the most reliable recession indicators. Of course, the broader yield curve as measured by the difference between two- and 10-year yields or even the gap between the federal funds rate and 10-year yields has yet to invert, but as I said before, there is an air of inevitability about it. Flattening yield curves always precede economic weakness. They aren't much good at exactly timing the top of the stock market, but you can get in the ballpark.
I suppose all recessions are a surprise to some extent. If you are a retail investor getting your news from popular websites or TV channels, you might not be getting the whole picture. In the professional community, it is becoming harder to ignore the very obvious warning signs that a downturn is coming. In bull markets, everything works. In bear markets, the only thing that really works is short-term government and municipal bonds and cash. Ample opportunity is being given to cut exposure to risk, and it's clear that few people are taking advantage of it. They never do.
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Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of "Street Freak" and "All the Evil of This World." He may have a stake in the areas he writes about.
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