Stocks will likely suffer another downturn as warning signs continue to flash for the market, according to research firm Trahan Macro. "We are staring at the worst macro backdrop for stocks in a generation," analyst Francois Trahan said in a note Wednesday. The research firm looked at 10 indicators that help investors gauge risk and reward for equities. These signals have consistently been flashed in the lead-up to past bear markets, which the firm defines as a greater than 15% correction. The variables include inflationary pressures, monetary tightening by the Federal Reserve and higher long-term interest rates, as well as valuations, underperformance of consumer discretionary stocks and volatility in financial stocks. "The key thing to know now is that nine of the 10 are currently flashing bright red lights about the risks of a bear market ahead," Trahan said. He noted the "strongly bearish 9 reading" began flashing before Russia invaded Ukraine in February. This is the fourth nine reading in about 50 years and all 10 variables have never flashed red simultaneously, he added. Stocks have struggled this year, with the S & P 500 dropping more than 7% after back-to-back years of strong gains. This year's losses come amid massive surges in U.S. consumer prices along with tighter monetary policy from the Fed. The central bank hiked rates last month for the first time in more than three years, in an effort to fight the recent inflationary pressures. The combination of elevated valuations in growth stocks, which are sensitive to rates and make up a significant portion of the S & P 500, and rising rates has weighed heavily on this year's backdrop for stocks, Trahan said. He also noted that that consumer strength that followed the global financial crisis is "likely about to wane" as record inflation eats into consumers' pockets – particularly among low- and middle-income consumers that account for 70% of economic consumption. The consumer discretionary sector is one of the best gauges of U.S. households' financial health, he said. The combination of a flattening yield curve and the underperformance of financial stocks is also a "bad omen" for the economy and financial markets, Trahan said. "In many ways, it is the Fed chasing inflation while PMIs are already losing steam that makes this backdrop so challenging," he continued. "Everything else on that list – like high valuations or an international crisis (pandemic or Ukraine?) – is just icing on the cake for what is already a difficult macro backdrop."
Traders work on the floor at the opening bell of the Dow Industrial Average at the New York Stock Exchange on March 18, 2020 in New York.
Bryan R. Smith | AFP | Getty Images
Stocks will likely suffer another downturn as warning signs continue to flash for the market, according to research firm Trahan Macro.