April saw markets rebound from the recent lows set in March, as progress combating the spread of the coronavirus gave hope to investors. The S&P 500 gained 12.82 percent during the month, marking the best single month for the index since 1987. While this swift rebound was quite welcome for investors, very real risks to markets still remain—and there are several key factors that matter when determining the overall risk level.

Recession risk

Recessions are strongly associated with market drawdowns. Indeed, 8 of 10 bear markets have occurred during recessions. As we discussed in this month’s Economic Risk Factor Update, right now the conditions that historically have signaled a potential recession are likely here. On an absolute basis, all of the major economic indicators that we cover monthly are now at a red light. As such, we have kept the economic factors at a red light for May.

Economic shock risk

There are two major systemic factors—the price of oil and the price of money (better known as interest rates)—that drive the economy and the financial markets, and they have a proven ability to derail them. Both have been causal factors in previous bear markets and warrant close attention.

The price of oil. Typically, oil prices cause disruption when they spike. This is a warning sign of both a recession and a bear market. In this case, however, the sudden drop is also a warning of significant disruption.

The price of oil fell by nearly 74 percent on a year-over-year basis in April, as lowered global demand continued to keep prices low during the month. This is the largest year-over-year decline on record, highlighting the effect that lowered demand has had on prices. The average price of oil fell from $26.46 in March to $16.61 in April, marking the largest monthly decline on record. This brought the average price of oil to its lowest level since 1999. Typically, lowered gas prices are a boon to consumers; however, with much of the country sheltering at home and limiting travel, the benefit was likely minimized during the month.

Going forward, sustained oil prices at these levels signal a risk, with the energy industry being massively disrupted, as we saw back in 2015. While lower prices would normally have also generated an offsetting stimulus, as consumers spend less to drive, the shutdown of the economy has eliminated that. Given the continued weakness in prices in April, we’ve downgraded this indicator to red.

Signal: Red light

The price of money. We cover interest rates in the economic update, but they warrant a look here as well.

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