Personal Wealth Management / Market Analysis

Are They Right About Recession?

The bevy of recent recession fears seems JUST a bit outside.

The US economy isn't taking this exit any time soon. Photo by ZargonDesign/iStock.

One way I spend my free time is by listening to past episodes of my favorite sports podcast. Specifically, listening to the hosts speculate about who will win or lose an upcoming football game and then comparing it with the actual result. Whether they are right about who won or lost is one thing, but I'm more interested in how their original rationale stood up to reality. I get to do something similar for MarketMinder, but rather than dissect talking heads' sports analyses, I dissect talking heads' economic analyses. Recently, there has been a lot of chatter about a recession happening in the not-too-distant future. Should folks be worried? In my opinion, no: These recession forecasts aren't new, and more importantly, the data don't suggest one looms.

First, let's make sure we're speaking the same language: A recession is a broad-based decline in economic activity over an extended period. Economists used to consider two quarters of contracting GDP a recession, and to some, this is still its "technical" definition. But it isn't perfect, since GDP isn't a perfect measure of economic activity. Nowadays, the National Bureau of Economic Research (NBER) is the official arbiter of US business cycles, and their say-so determines whether we are in or out of recession. NBER's definition:

A significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales.

This is more specific, which is helpful. However, it also means we can't officially define a recession's start in real-time because of the data's backward-looking nature. Also, note that while recessions can start for a number of reasons, slowergrowth isn't one of them. Another off-base recession rationale: "old age" (as in the expansion, not old people. Then again, more old people-a demographic trend-is sometimes feared to hamper the economy, and that's wrong too).

Today's recession fears indicate more about overall sentiment than economic reality. Throughout this expansion, economic pundits have constantly warned a contraction is right around the corner. TheWall Street Journal, for example, has a "Recession Probability" section in its monthly "Economic Forecasting Survey," which made waves recently because the surveyed economists estimate the likelihood of recession within the next four years is 60%.[i] For much of this expansion, respondents to the Journal's survey pegged the likelihood of recession occurring in the next 12 months somewhere in the 15-20% range, with the October survey showing a 20% expected likelihood. A (wrong) minority, to be sure, but one that constantly headlines the financial news-evidence of the media's penchant for prioritizing the scary possibility over the less exciting probability. Headlines celebrating the fact 80-85% of economists think growth continues are, well, rare.

TheWall Street Journal isn't alone in recession speculation, as it's a popular pastime for the financial commentariat. However, that doesn't mean investors should play along. Through all the "looming recession" talk, stocks have kept rising. (Exhibit 1)

Exhibit 1: That Recession Wall of Worry

Source: FactSet, as of 10/20/2016. MSCI World Total Return, from 6/30/2009 - 10/20/2016. Article titles are listed in chronological order here, here, here, here, here.

While it's popular to mistrust or disregard what capital markets signal (e.g., stocks must be missing something !), consider the alternative: Markets are often much more efficient than models or individual forecasts at pricing in reality. They aren't perfect, and they certainly can be volatile in the short term, but stocks are better at digesting the current economic environment than academic models and forecasts that depend on certain (frequently biased) assumptions, theory and all-else-equal conditions that never actually exist.

Of course, at some point, we'll get a recession. That's how our boom-and-bust economy works. But for the time being, more growth seems likely. The New Orders subindexes of both manufacturing and non-manufacturing purchasing managers' indexes have consistently topped 50, suggesting a majority expect business to grow for the foreseeable future-today's orders are tomorrow's production. While the yield curve (the spread between long-term and short-term rates) flattened at points earlier this year, causing some angst, it never inverted-which is what matters most. The yield curve determines loan profitability, and since banks are in the business of making money, a positive spread suggests they'll continue lending capital, which borrowers will use to try and create more wealth. In recent weeks, it has started to steepen again, suggesting more growth awaits. The yield spread is also in The Conference Board's Leading Economic Index (LEI), which rose 0.2% m/m in September. Despite some bumpiness in recent months, what matters most is LEI's longer-term story. In LEI's 50+ year history, no US recession has started when it was high and rising like it is today.

The emphasis here isn't on any one forecast and whether it is right or wrong. Rather, it is more important for investors to recognize that these projections are limited and always subject to change. The danger would be in making changes to your portfolio because of an off-base forecast. With the barrage of news out there about the economy, politics and everything else, the noise can be deafening. However, taking the time to check a little history and look at the data yourself-sans media hype-can reveal a reality that's better than popularly portrayed.

[i] I reached out to the author of the article to ask for the historical background behind this question. Unfortunately, they don't make that particular question publicly accessible, like they do for their other questions. Alas.

If you would like to contact the editors responsible for this article, please click here.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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