Since mid-2022, concerns about an impending recession in the United States have been making headlines. However, despite various warning signs and indicators, the U.S. economy has shown resilience over the past nine months.
So, what’s happening? In this blog post, we’ll explore the factors that have fueled recession concerns, discuss the current state of the U.S. economy, and examine whether investors should be worried about a potential recession.
Understanding a Recession
Typically defined as two consecutive quarters of contracting gross domestic product (GDP), a recession indicates a significant decline in economic activity. By this definition, the U.S. economy is not heading for a recession, as GDP grew by 1.3% in the first quarter of 2023.
The National Bureau of Economic Research (NBER) is responsible for officially declaring recessions. Its definition is somewhat vague but emphasizes significant and sustained decline in economic activity across various sectors.
Mixed Economic Signals and Concerns
Mixed economic data has economists divided on whether a recession is imminent.
The Federal Reserve’s projection of low GDP growth for 2023 and successive interest rate hikes have raised concerns about a potential economic decline. A minor banking crisis, resulting in the failures of some financial institutions, also fueled worries.
Moreover, inflation has remained above the Fed’s target, prompting rate hikes that affect corporate investments and consumer loans. As a result, analysts expect negative earnings growth for S&P 500 companies, while a tightened credit market has reduced lending to corporations and consumers.
Meanwhile, the yield curve has been inverted since the middle of 2022, as the yield on 2-year U.S. Treasury notes has exceeded that of 10-year Treasury notes. An inverted yield curve can be problematic as it frequently appears before an economic downturn.
And the New York Federal Reserve’s recession probability indicator, which uses the yield curve’s slope to predict U.S. recessions, suggests a 68.2% chance of a recession in the next 12 months—its highest reading in four decades.
Yet while some indicators have sparked concerns, the current strength of the U.S. labor market and economic activity has divided economists on the inevitability of a recession. In addition, positive earnings, as well as guidance from retailers like Walmart, indicate that consumer spending remains strong.
Though slightly below estimates, retail sales grew for the first time since January. The resilience of the U.S. economy has surprised experts, suggesting that a recession may be farther in the future than expected.
What Does a Possible Recession Mean for Investors?
While concerns about a U.S. recession persist, the economy’s current state and the labor market’s ongoing strength suggest that an immediate downturn may not be inevitable. However, in the event of a recession in the second half of 2023 or early 2024, investors need not panic. Historically, recessions have been relatively short-lived, with an average duration of around 10 months.
Economic downturns also tend to present attractive opportunities for long-term investors, with the S&P 500 generating an average return of 40% in the 12 months following the market’s low point during a recession. In addition, some stocks, such as Target, Walmart, and Home Depot, have historically performed well during recessions.
Thus, despite the potential risks, investors should take a long-term perspective and consider the historical patterns of economic cycles. Recessions, although challenging, have often paved the way for favorable investment opportunities.
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