More Evidence a Recession Wouldn’t Shock Now

On the heels of December’s yucky manufacturing purchasing managers’ indexes (PMIs), services and composite PMIs are now rolling in and—once again—indicating broad-based contraction. Perhaps contraction is less broad-based than manufacturing, given services readings are closer to 50. Yet most are still below, suggesting contraction. Yet as we wrote earlier this week, what likely matters to stocks looking forward isn’t whether economies shrink, but whether any recession is a surprise or surprisingly nasty. A quick tour of the latest surveys of economists, CEOs and fund managers shows recession is a popular forecast this year, suggesting negative surprise power is quite limited.

Perhaps most striking: The Philadelphia Fed’s quarterly survey of professional forecasters, which tracks a few dozen economists’ GDP growth projections for the next several quarters. From their forecasts, the Philly Fed calculates the mean probability of GDP growing (or contracting) at a given rate. In Q4, economists put the mean probability of a recession occurring within the next 12 months at 43.5%. That is the highest estimated probability in the series’ history, which begins in 1968.

Exhibit 1: Philly Fed Survey of Professional Forecasters

Source: Federal Reserve Bank of Philadelphia, as of 1/5/2023. Shaded areas indicate NBER recessions.

Exhibit 2 collates a number of other, similar surveys—all showing business leaders, economists and professional investors see a very high likelihood of recession this year.

Exhibit 2: Major Surveys at a Glance

Source: Federal Reserve Bank of Dallas, The Wall Street Journal, Bank of America, Bloomberg, Barron’s, Federal Reserve, PwC, AICPA and The Conference Board, as of 12/29/2022. Note: The Fed’s Senior Loan Officer Opinion Survey doesn’t normally include questions about recession. But researchers elected to include a special set of questions on recession in October, which illustrates just how front-of-mind recession worries are presently. 

In our view, there are a couple encouraging things to glean from this. One, perhaps most obviously, if a recession strikes, it won’t be a surprise. Not to the pros, not to the masses and not to stocks, which are well aware of these surveys and what they represent. Given stocks reflect all widely known information, they have probably already incorporated these projections into current prices. That probably has a lot to do with the bear market that began a year ago and, perhaps, the inverted yield curve. Therefore, if a recession becomes official, far from being a shocking bad thing that stocks will have to grapple with, it would just confirm whatever they already priced in. Events like that tend to ease uncertainty and help stocks move on.

Two, business leaders tend not to just sit on their hands and wait for economic data to confirm recession. Rather, falling stock prices, weak earnings projections and widespread recession forecasts create an incentive to get lean and mean to survive whatever bad times could lie ahead. A recession’s general purpose is to wring out accumulated excess—the more wringing, the deeper and longer they tend to last. But this time, we are already seeing a lot of those cuts—witness all the recent layoff announcements, many of which include plans to cut real estate holdings and investments. If companies are getting lean and mean now, that suggests there wouldn’t be much more to trim by the time recession becomes official—if it becomes official—which speaks to it probably being short and shallow. That also argues for stocks having pre-priced this risk.