by Franklin J. Parker, CFA
The Summary
- This week we get some important data on both the economy and inflation. New home sales, consumer confidence, durable goods orders, PMIs, and personal consumption expenditures (on of the Fed’s preferred measures of inflation) are all on tap. In general, expectations are low for these figures. Durable goods, new home sales, and consumer confidence are all expected to tick down with PMIs remaining in contraction territory.
- With the Fed meeting out of the way, most eyes are turning to earnings season starting next month. At the moment, investors are expecting another quarter of shrinking earnings. While this could be short-lived, it is yet another signal that the economy is sputtering. My view is that a recession is likely within the next 6 months or so, but I have yet to get the “a recession is imminent” signals. This puts markets in a bit of a middle ground without a firm catalyst to move, either higher or lower. I continue to look for opportunities to reduce portfolio risks for those whose goals warrant such moves.
A Look at Recession Probabilities
Let’s cut to brass tacks and look at a few recession probability models.
I spend quite a bit of time talking about individual data points. That is important because each one is a piece of the mosaic that is our economy. Sometimes, however, it is easier to simply skim over those figures and wonder “So what?”. This week, let’s put that mosaic together in a more concrete way.
I have several models that I review to try and parse the business cycle. My simplest model is in the chart below. As you can see, it is indicating a 94% probability of a recession by January 2024, which is the highest this indicator has been since the early 2000s. Much of the intensity of this signal is coming from the yield curve, which has reached its most extreme inversion since 1981, but that is not the only input to this model.
In addition to my simpler model, I have a more advanced model that leans on more data and some AI techniques to combine. I trust it a little less because the only out-of-sample recession in the model was 2020 (which it did accurately predict, as did my simpler model). At any rate, this model is also showing increasing odds of a recession.
The NY Fed’s recession indicator, which is based solely on the yield curve, has a recession probability of 71%, which is the strongest it has been since the early 1980s (when the US experienced two back-to-back recessions).
The Conference Board’s recession probability model has the possibility of a recession by February 2024 at 99%. That is higher than their model indicated just before 2008. They see the downturn starting the third quarter of 2023.
And, of course, there are the various commercial models out there. Bloomberg’s recession probability model is at an elevated 65%. The point is, no matter who does the slicing, the data seems to point to a recessionary environment.
This is a good time to point out, however, that just because a recession is looming does not mean markets won’t move higher. First, there is the possibility that a recession does not form. Second, however, it is not unusual for markets to rally into the end of a business cycle, as we discussed in our May 1 update.
Of course, exactly how you implement this outlook in your investments will depend on your financial goals, but that is a conversation you should be having now.
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