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Recession Fears Are Grinding to a Halt -- Here's What's Next For Markets

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Economic developments are sending signals to forecasters that a recession may not come as soon as many had previously anticipated. The recent incremental upward revisions for economic growth are bringing about somewhat renewed optimism, but also a slightly altered picture of what to watch for going forward.

The S&P 500 is up 7.8% since October 8. The 10-year treasury yield, which bottomed at roughly 1.5% for the year, is now at 1.81%. And the yield curve is no longer inverted, with the 3-month treasury yield at roughly 1.5%. The fact that the yield curve was inverted for a few months, could certainly signify a recession is less than three years away. But recent economic data suggests the U.S. is further away from shrinking than previously thought.

GDP growth for the third quarter was 1.9%, beating expectations of 1.7%. Inflation of just below 2% has been supported by lower interest rates (and rate cuts), according to Federal Reserve Chairman Jerome Powell. Stock investors are also growing optimistic on a U.S. - China trade war resolution, though it remains far from concrete.

What to Watch Now

Now, recession probability estimates for the next 12 to 18 months are falling. On October 7, the National Association For Business and Economics said

the chance of a recession by the end of 2020 was 60%

. Since then, Stifel's Head of Equity Strategy Barry Bannister wrote in a note "We think a recession has been delayed." Glenmede's Chief Investment Officer of Private Wealth Jason Pride wrote in a Monday note "Recession fears abating." Glenmede's estimates for a recession in its time-frame is a "still-low" 22%. LPL Financial's Senior Market Strategist Ryan Detrick wrote in a note "We see near-term recession risk as low, but we'll continue to monitor data for any late-cycle or recessionary signals."

Investors now seem to be less starved for interest rate cuts, although monetary tightening is not in the cards, which may remain the case until a recession comes and goes. Central banks around the globe had been aggressively lowering rates. Banks will likely remain accomodative, but that policy looks to be moderating some.

For the U.S., Powell said current policy is "appropriate," but that he will cut rates if the data deteriorates. The probability of a March 2020 rate cut is 0.7%, according to data from CME Group. "This week investors will be looking for further evidence that top central bankers are set for a period of inaction," wrote UBS' Chief Investment Officer of Global Wealth Management, Mark Haefele in a Monday note. The German 10-year bund was yielding negative 0.7% in September. It now sits at negative 0.3%.

When new European Central Bank President Christine Lagarde speaks this week, U.S. investors should listen. If the ECB is prone to cutting rates sooner rather than later, U.S. rates could fall too. When global interest rates fall, global bond investors sometimes move into the higher yielding U.S. treasuries, pushing those yields down (bond prices move inversely to yields). This can cause momentary confusion, where U.S. rates paint a more bearish picture than the economic data shows.

What This Means For Stocks 

Holistically, if global interest rates are more stable and decline at a slower rate, this floor for economic growth may be removed. But the market isn't viewing this negatively. Instead, a higher probability of a trade-war resolution is seen as a factor that outweighs a lower probability of rate cuts. And the same goes for slightly better economic data.

While these factors will have an impact on stocks, the S&P 500 is already up 24.5% year-to-date. Still, the average stock on the S&P 500 is valued at 17.5 times next year's earnings. That multiple  is slightly elevated compared to the average over the last 10 years, but many on Wall Street still believe its fairly valued, leaving upward revisions in near-term earnings estimates to be the main driver of any stock price gains, rather than multiple expansion. 

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