Recession Outlook Summary
- Our Recession Probability Model rose across all horizons in the first quarter of 2019. While near-term recession probability is limited, the probability of a recession occurring over the next 24 months has more than doubled.
- The deterioration in leading indicators, inversion of the yield curve, and tightening of monetary policy all contribute to rising recession risks. As we expect these trends to continue in 2019, we should see recession risk rise throughout the year.
- We maintain our view that the recession could begin as early as the first half of 2020, but will be watching for signs that the dovish pivot by the Federal Reserve (Fed) could extend the cycle.
- The next recession will not be as severe as the last one, but it could be more prolonged than usual because policymakers at home and abroad have limited tools to fight the downturn.
- Credit markets are likely to be hit harder than usual in the recession. This stems from the record high ratio of corporate debt to GDP and the likelihood of a massive fallen angel wave.
- When recessions hit, the magnitude of the associated bear market in stocks is driven by how high valuations were in the preceding bull market. Given that valuations reached elevated levels in this cycle, we expect a severe bear market of 40–50 percent in the next recession.
Investment Implications
Prepare for a Steep Decline in Risk Assets
On the surface, this scenario may not seem particularly dire for investors. But we would caution that market behavior is only loosely correlated with economic conditions, and a moderate recession does not mean moderate market movements. On the contrary, years of low interest rates have served to amplify the financial cycle over the past few decades, and this amplification has been further heightened in the current cycle by asset purchases by global central banks.
