Is A Recession Coming? – Forbes Advisor

Since mid-2022, Americans have been told that a recession is approaching. But over the last nine months, there’s been no sign of any economic downturn in the U.S. What’s going on?

Rising interest rates, high inflation, an inverted yield curve, and an unexpected banking crisis have all been cited as reasons that a recession could be imminent.

The New York Fed recession probability indicator suggests a 68.2% chance of a U.S. recession sometime in the next 12 months. That’s the highest reading in more than four decades. Other reliable economic indicators are warning signs that the U.S. economy could soon roll over.

But despite all these factors, the U.S. labor market remains strong, and economists are divided on whether or not a recession is inevitable in this unique economic environment.

Just because some experts believe the risk of a recession is rising, there’s no reason to panic. Recessions are a relatively common occurrence—and they’ve often generated attractive opportunities for long-term investors.

What Is a Recession?

There is no universal definition, but analysts and investors commonly consider two consecutive quarters of contracting gross domestic product (GDP) as a recession.

U.S. GDP gained 1.1% in the first quarter of 2023, and the Atlanta GDPNow model is currently projecting another 1.7% gain in U.S. GDP in the second quarter. By this standard definition, we are not heading for a recession.

In the U.S., the National Bureau of Economic Research (NBER) is tasked with officially calling recessions, although its definition of a recession is somewhat vague. NBER says a recession is “a significant decline in economic activity spread across the economy and that lasts more than a few months.”

Right now, companies are still hiring, and consumers are still spending. The U.S. economy added 253,000 jobs in April, far exceeding economist estimates of 180,000 new jobs. That type of job growth doesn’t typically coincide with a U.S. recession.

Why Are Investors Worried About a Recession?

In March, the Fed projected full-year 2023 GDP growth of just 0.4%, suggesting economic growth could quickly dip into negative territory in the year’s second half.

Since then, the central bank has kept raising interest rates, and a minor banking crisis led to the failures of Silicon Valley Bank, Signature Bank, and First Republic. The minutes from the April Fed meeting disclosed that officials thought the situation could push the economy into recession.

“Given their assessment of the potential economic effects of the recent banking sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years,” stated the Fed meeting minutes.

The Fed will release the minutes from its May meeting on May 24.

Inflation Is the Tail That Wags the Dog

The most recent core personal consumption expenditures price index data showed that this key measure of U.S. inflation was up 4.6% from a year ago. While it’s down significantly from peak 2022 levels, core PCE remains well above the Fed’s long-term target of 2%.

That latter point is why the Fed has raised the federal fund’s target rate range by 5% since March 2022. But while raising rates can help lower inflation, the higher they go, the more expensive it becomes for U.S. companies to invest in innovation and growth.

In addition, higher rates increase the costs of loans for regular Americans. Credit card balances, mortgage loans, and auto loans are more expensive, reducing the disposable income people have to spend and weighing on corporate earnings and stock prices.

Analysts expect S&P 500 companies to report a 6.3% year-over-year earnings decline in the second quarter, the third consecutive quarter of negative earnings growth.

The banking crisis has further tightened credit markets, reducing banks’ willingness to lend to corporations and consumers.

The Inverted Yield Curve Flashes a Recession Warning

One warning sign of a U.S. recession has flashed for investors since mid-2022. The yield on 2-year U.S. Treasury notes jumped above the yields on 10-year Treasury notes, a phenomenon known as a yield curve inversion.

Inverted yield curves have historically been a solid economic recession indicator. Historically, two-thirds of the time the yield curve has inverted, the U.S. economy has fallen into a recession within 18 months.

The last time the yield curve inverted was in late 2019, just a few months before the Covid-19 recession. In early 2023, the yield curve inverted to its deepest level since 1981.

The Case Against an Imminent Recession

Despite these warning signs, plenty of economists and analysts say the U.S. economy is too healthy for a recession to be imminent.

David Trainer, CEO of New Constructs, says investors can watch the earnings reports and guidance from discount retailer Walmart (WMT) as an indicator of the health of U.S. consumers. Walmart reported first-quarter earnings and revenue beats in May and raised its full-year guidance.

“Walmart is a bellwether for consumer spending and health, which is not in dire straits, but weakening,” Trainer says. “Walmart’s earnings add to the idea that a recession is not fully here yet but is likely coming, albeit more slowly and less severe than most expect.”

U.S. retail sales grew 0.4% year-over-year in April, led by miscellaneous store retail sales growth of 2.4%. Retail sales growth fell short of economist estimates of 0.8%, but it was positive for the first time since January.

Chris Zaccarelli, chief investment officer at Independent Advisor Alliance, says he has been pleasantly surprised by the resilience of the U.S. economy.

“Retail sales came in strong again, showing how the consumer isn’t showing any signs of slowing down and that the recession many are forecasting is farther into the future than anyone would expect,” Zaccarelli says.

The Labor Department’s May U.S. jobs report on June 2 could be particularly telling for investors on recession watch.

Should You Be Worried About a Recession?

If the U.S. does slip into a recession sometime in the second half of 2023 or early 2024, there’s no reason for investors to panic.

First off, historically, recessions don’t last very long. The average duration of a U.S. recession since World War II is just 11.1 months. The Covid-19 recession in early 2020 lasted just two months.

U.S. recessions are pretty standard. Since World War II, there has been about one U.S. recession every five years.

While recessions can lead to job losses and other financial difficulties for Americans, they have historically been excellent buying opportunities for long-term investors. It can be challenging for investors to time a market bottom perfectly, but the S&P 500 has generated a 40% average return in the 12 months following its low point of a U.S. recession.

Some stocks even have a track record of performing relatively well during recessions. For example, Target (TGT), Walmart, and Home Depot (HD) shares significantly outperformed the S&P 500 during the 2020 and 2008 recessions.

Jeffrey Buchbinder, chief equity strategist for LPL Financial, says recession risks are ahead. Still, investors shouldn’t under-appreciate how much the U.S. economic outlook has improved in recent months.

“While the ‘better than feared’ label fits the past couple of earnings seasons quite well, based on the magnitude of upside surprises in the first quarter and encouraging guidance from corporate America, that’s probably underselling it,” Buchbinder says.