Is a U.S. Recession Looming?

Is a Recession Looming?

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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Thoughts on the Covid-19 Induced Stock Market Volatility

It’s hard not to think back to the financial crisis and resulting recession of 2007-2009 when watching the stock market volatility today. That was a painful period for many, especially those who were laid-off, small business owners, retirees, or those planning to retire soon. Actually, it was a pretty tough time for everyone for one reason or another. Afterward, it took years to fix the damage to the financial system and the economy, but the economy did recover.

The Current Market

The current market volatility is unprecedented, but we know the cause. Markets (meaning investors who buy stocks) hate uncertainty and uncertainty exists on many fronts right now. We don’t yet know the answers to questions such as:

When will the rate of infection slow down?
How long will it take to develop a vaccine?
How long will we have to shelter in place?
How long will restaurants, bars, retail stores, and other businesses stay closed?
How will reduced sales affect the profits of companies and their stock prices?
And many more.

It is logical that the volatility will subside once we have answers to these questions. And, our new reality of elbow bumping, hand-washing, social distancing, shelter-in-place, work-at-home practices will undoubtedly help to slow the spread and give experts time to develop a vaccine.

Unfortunately, the wait and this new way of life will come at a cost. The decline in economic activity of all types will most likely lead to a recession if we aren’t in one already. Recessions are painful but they do end and so will this one.

The below chart illustrates past world epidemics and global stock market performance. The MSCI World Index includes the U.S. and worldwide stock markets. You can see that recoveries from bear markets are swift in most cases:

You might wonder whether it makes sense to sell now and get back into the market later. But stock market history has shown that missing out on even a few days of positive market returns can derail this strategy as illustrated in the chart below.

The best course of action right now is to take a deep breath and wait this out. Better times are surely ahead.
Chart from VanguardFurther reading:  Freaked Out by the Stock Market? Take a Deep Breath

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