Is it time for Defense Mode? Several historical parallels with the past indicate that we should be on guard.

Market prices are influenced by monetary cycles and human emotions; that’s why models matter. Moreover, history often repeats itself, or at least rhymes.

Throughout the year, we have noticed similarities between the current situation and the financial crisis. Over time, these similarities have become more numerous and accurate. Does this mean we will fall into the same depth of despair as felt in 2007 and 2008? Will we go through economic corrections with much less severe consequences? Or will we continue with the greatest asset expansion in history without any difficulties?

Here are some notable similarities between what we are observing and what we saw before and during the financial crisis:

Beneath the Surface

In the bigger picture, just like in 2007 and 2008, the market was near a historic high, unemployment was comfortably below 5%, real estate was at its peak, homeowners were borrowing against their equity, and every day people were leaving their jobs to trade on the financial markets. We were told the economy was thriving and everything was fine. Analysts made bold statements like “No recession in sight.”

But beneath the surface, signs of turmoil were emerging. For instance, stories about accounting irregularities began to surface, and Boeing workers went on strike in September 2008, just before a tense election season. Does this sound familiar?

The Yen Carry Trade

The most obvious analogy is the unwinding of the yen carry trade, which ignited the spark for the 2007 financial crisis. The stock market immediately corrected but never fully recovered from its upward trend, ultimately undergoing a 50% correction.

The Rate Cut Cycle

On September 18, 2024, the Federal Reserve began a rate-cut cycle with a rare 50 basis points move. In 2007, the rate-cut cycle also started on September 18 with a 50 basis point cut.

Prolonged Yield Curve Inversion

The prolonged inversion of the yield curve was reversed in the summer of 2007. In the summer of 2024, we also saw a similar inversion, which turned positive.

This chart illustrates the phenomenon in 2007; the blue line represents the spread between 10-year and 2-year government bonds. When the spread becomes negative (below the black line), it is considered inverted. Historically, this has been a harbinger of recessions, but the recession often arrives months after the curve returns to positive territory. Will it be different this time? Unlikely.

S&P

The S&P hit a record high in July 2007, followed by a recovery in September/October that failed to hold and succumbed to selling. Is this what we are witnessing now?

The Elections

Similar to 2024, 2008 was an election year. Before the elections, the market had already fallen by about 25% from the previous year’s highs and lost another 25% before bottoming in March 2009. Will the election season of 2024 lead to a significant correction in the stock market?

Too Many Red Flags to Be Comfortable

The stock market is designed to rise over time, so it’s not wise to be permanently negative.

In rare cases, the stock market experiences shocking blows to the bulls, and for decades there have been precedents for lost stock market gains in the U.S. Ignoring dividends, the S&P’s peak during the dot-com bubble wasn’t surpassed until 13 years later. It’s not impossible to argue that in 2024 we’ve stretched stock market prosperity, and it will take time to catch up with the math, as happened in the early 2000s.

The long-term chart of Japan’s primary stock index, the Nikkei 225, is even more astonishing. While our central bankers haven’t been as aggressively creative as those in Japan, they have employed many of the same tactics. The Nikkei 225 skyrocketed in the 1980s and peaked in 1990 just below 40,000, a level not seen again until this year (almost 35 years later).