The ASX 200 is down 5% in two days: What happens next?

The S&P/ASX 200 has now lost around 400 points or almost 5% in the last two sessions. Without a significant rebound by close, this could mark the worst two-day loss since March 2020.

The last time the ASX 200 experienced a two-day selloff of 5% or more was on 23 March 2020, when the pandemic was in full swing.

Global equity markets were rocked last Friday following a series of disappointing US economic data releases, including weaker-than-expected unemployment and manufacturing data.

Below, we'll highlight some key factors moving markets and how they have historically performed after a sharp two-day selloff.

How Did We Get Here?

The US unemployment data, which fell well below market expectations, served as the primary catalyst for recent market movements.

• July nonfarm payrolls grew by 114,000 compared to 175,000 consensus

• Unemployment rate ticked higher to 4.3% vs. 4.1% consensus

This data follows last Thursday's US jobless claims, which reached their highest level in nearly a year, and the July ISM Manufacturing Survey, which missed estimates and remained in contraction territory. Notably, the survey's employment component hit its lowest point since June 2020.

Why does this matter? The unemployment data triggered the 'Sahm Rule', a historically reliable indicator for predicting recessions. This rule states that the economy is in recession when the three-month moving average of the national unemployment rate exceeds the lowest three-month moving average from the previous 12 months by 0.50 percentage points or more. Since 1953, the Sahm Rule has never been wrong, gaining recognition for its simplicity and accuracy.

In response to these developments:

• Goldman Sachs raised their 12-month recession odds from 15% to 25%

• JPMorgan estimated a 50% probability of a US recession

The data prompted a sharp selloff in Treasury yields, with the US 2-year yield dropping 26 bps last Friday to 3.85%. While lower yields can be beneficial for stocks and the economy, there's a fine line between positive and negative implications.

The good: Bond yields eased in mid-November 2023 due to cooler-than-expected inflation data. During this time, October headline inflation decreased to 3.2% from 3.7% in the previous month and below 3.3% consensus.

The bad: The US 2-year Treasury yield chart shows three sharp red bars in March 2023, coinciding with the US banking crisis. Two lenders collapsed, intensifying fears of contagion and triggering a severe sell-off across the sector. The most recent bar reflects current recession fears and concerns that the Federal Reserve may be behind the curve, potentially needing to cut rates sooner than anticipated.

US 2-year yield weekly chart (Source: TradingView)

The bottom line is that there is a point where growth risks outweigh the prospect of lower yields and interest rates.

What Happens Now?

Since 2008, the ASX 200 has experienced 49 instances of falling 4% or more over two consecutive sessions. The majority of these occurrences – 34 to be exact – were concentrated during two major economic crises: the 2008 Global Financial Crisis and the 2020 pandemic.

To provide a clearer picture and avoid data clutter, I've only included the first instance of such a decline in each month. For example, while October 2008 saw 8 such instances, only one was counted in this analysis.

Source: Market Index

At a glance, the data tells us:

• A short-term market bounce is possible as extreme oversold conditions begin to ease

• However, near-term returns face challenges. The one-to-six-month outlook remains relatively flat, with an underwhelming percentage of positive returns.

• The long-term outlook remains bullish. Twelve-month forward returns are generally positive, boasting a solid percentage of positive outcomes.

• This positive long-term trend holds true as long as a recession is avoided. The twelve-month data only turns negative during severe economic downturns, such as in 2008 (with an average twelve-month return of -30.5%)

The market has suddenly become very challenging.

Could the market stage a bit of a bounce after such a sharp selloff? It could.

Could it continue to sell off and undershoot to the downside? Also possible.

With things getting messy, it's important to respect risk, avoid rash decisions and let's see how reporting season plays out.