The odds of a recession are still moderate and are projected to be only at 25%, despite a global slowdown and plummeting crude oil prices, according to experts.
The probability that a recession will occur in the U.S. has risen to 25% for the next 12 months, according to Ken Chen, an economist for BBVA, the Madrid-based financial institution. The projection is based on several models scrutinizing economic data from the manufacturing sector, declining profits of S&P 500 companies and financial indicators that “may reflect a weakening global economy,” he wrote in a report.
“The current economic indicators are sending alarming signals pointing to a future economic recession,” Chen wrote. “In addition to deteriorating profits faced by many companies, sharp declines in rail traffic may also reflect weakening demand in the global economy.”
While the pressures that caused the recession in 2008 were “really scary,” the current economy is facing different headwinds which are related to financial pressure and volatility, said Mohamed El-Erian, chief economic advisor at Allianz, a Munich-based financial services company, told TheStreet in an earlier interview. The odds of a global recession in 2017 are 30%, but he predicts it is lower for this year.
A recession is not likely to transpire, because the strength in the U.S. economy is being balanced by weakness in Europe, China and in the oil patch, said Harlan Platt, a finance professor at the D’Amore McKim School of Business at Northeastern University in Boston. Instead of panicking, investors should look for strong companies whose stock are “showing softness in the face of very strong earnings, he said. “An example is Disney which is down about 25% with higher earnings. The main way to lose money is to buy winners at the top, especially when those winners are concept stocks which have yet to prove themselves,” Platt said.
Despite the continuation of volatility in the stock market, embrace the opportunity to buy tech stocks off their recent highs such as Amazon (AMZN) - Get Amazon.com, Inc. Report , which is down about 20% the past few weeks, and LinkedIn (LNKD) , which is down about 50%, said Stephen Ciccone, a finance professor at the University of New Hampshire's Peter T. Paul College of Business and Economics in Durham. Investors can also consider purchasing broad-based stock index funds.
Stock Market Is Not a Good Indicator
The emphasis placed by many people on the stock market as a leading economic indicator to determine the probability of a recession is not accurate, said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa. The assumption is that since the markets are volatile and have declined during the recent massive selloffs, the economy is headed into a recession.
“While the stock market in general is a good leading economic indicator, there is certainly not a perfect correlation,” he said. “Noted economist Paul Samuelson once said that the stock market has predicted nine of the last five recessions.”
The most notable deviations from the ability of the market to forecast recessions occurred in 1987 when the stock market crashed, but strong economic growth followed it, Johnson said. In 2011 and 2012, the stock price volatility “pointed to a recession and the ensuing GDP growth was pedestrian, yet positive,” he said.
A recent survey of Wall Street economists pegged recession odds at about 20 percent, which seems “plausible given the broad economic indicators and global issues,” Johnson said.
The odds are “very high” that a recession will occur because the global economy is in a recession and will “drag the U.S. economy down with it,” said Ken Moraif, a CFP and senior advisor at Money Matters, a Dallas wealth management firm with $2.9 billion in assets under management.
“The historic amounts of debt by consumers, businesses, and the federal government have made economic growth very difficult without the additional drag of a global recession,” he said.
Other Economic Indicators
The traditional leading indicator for an economic recession is the Treasury spread, which determines the rates between 10-year Treasury notes and 3-month Treasury bills, said Chen. The New York Federal Reserve’s forecast for a recession is negligible. Some economists argue that other indicators are more effective at determining the state of the economy such as the decline of rail traffic or manufacturing data.
“The decline of earnings-per-share reflects weakening on the corporate side,” he said. “This does not guarantee a recession unless there are more signs going forward.”
The technical definition of a recession is when two or more consecutive calendar quarters occur in which GDP declines, said Keith Baker, a mortgage banking and personal finance professor of North Lake College in Irving, Texas. While the GDP has demonstrated small declines for the first quarters of 2013 to 2015, the Fed’s decision to raise interest rates in December “might appear to be causing another weak first quarter in 2016,” he said. “These short-lived GDP declines early in each of the past three years may have some more structural causes that will not go away any time soon or we could enter a recession.”
Predicting when a recession might occur is not easy, but some other indicators which demonstrate a slowdown include a continued decline in corporate profits, a drop in in factory orders, a dip in export growth and a slowdown in retail sales.
Defensive Moves By Consumers
Americans can gird themselves for a downturn by updating their current job skills and responsibilities to make themselves “most likely be the last one chosen for any current unlikely layoffs in the future,” Baker says. He also advises being frugal by paying down credit cards with higher interest rates.
Instead of paying down debt since interest rates are historically low, consumers should invest their excess cash for a potential “rainy day,” especially if their job is cut, said Ciccone.
Saving for retirement should not be halted, but Americans should consider rebalancing their portfolios to include more defensive stocks.
“Don't just stop investing because the amount of money invested each month when the market is going up and down will yield an attractive average investment return over many years,” Baker said.
Volatility can be viewed as an opportunity to add investments while they are cheaper, but investors should resist the urge to change asset allocation too often, said Allison Alexander, a financial advisor with Savant Capital Management in Rockford, Ill.
“Long term investors are rewarded for their patience,” she said.
Since World War II, there have been 12 recessions lasting an average of 10 to 11 months, which includes large increases in unemployment, said Kevin Jacques, a finance professor at Baldwin Wallace University in Berea, Ohio and former senior economist with the U.S. Treasury Department. Consumers should ensure they have a minimum of six months in living expenses saved because the current length of being unemployed is nearly 29 weeks.
“Having at least six months of living expenses available becomes essential since it means unemployed individuals will not have to take money out of retirement funds in order to finance their day-to-day expenses,” he said. “Using money set aside for retirement to finance current living expenses can have devastating long-term consequences.”
Without further negative signs, consumers do not need to panic, said Ciccone.
“If there is a recession, I do not expect anything near a 2008-style meltdown,” he said. “The job market seems stable with unemployment levels continuing to decline. The current rate of about 5% is actually very similar to the rates prior to the 2008 recession period.”