The stock market and the U.S. economy is off to a bumpy start in 2016, sparking fears that the U.S. will soon fall into its first recession since the Financial Crisis. However, financial markets are often driven more by emotion than reason. Is the U.S. actually on the precipice of a recession, or are markets overreacting?
It’s hard to argue with slowing U.S. economic growth, which dropped to an annualized rate of 0.7 percent in the last quarter of 2015. But while job growth contracted to only 151,000 in the month of January, growth is still growth.
Fears about the impact of economic decline in China are also spooking financial markets. While China’s growth rate slowed to a 25-year low in 2015, it remains at 6.9%, enviable by any developed market standards. Even if things go from bad to worse, China exports represented less than 1% of U.S. GDP last year.
Crude oil prices have gone from low to lower in 2016, and the collapse of the U.S. shale industry has weighed heavily on the overall U.S. economy. Morgan Stanley is the latest Wall Street firm to lower oil price projections and now expects crude oil to remain below $30/bbl for at least another year, putting even more pressure on most of the energy sector.
Unfortunately, there’s no sure-fire way to predict a recession, but many business executives have weighed in on the controversy in recent weeks.
Jeremy Freedman, CEO of Gluskin Sheff & Associates Inc believes that fears of a recession are unwarranted. “There is not a very high likelihood of a recession to the U.S. or globally,” Freedman said on Feb 4. “We think the markets have priced in much worse news.”
David Gladstone, chairman and CEO of Gladstone Investment Corp., is not quite so optimistic. “It’s our opinion that we may be entering a recession now and we need to be very, very cautious,” he said on Feb 4. “We don’t see anything on the horizon that indicates a strong economy, but there are some signals out there that we are entering recession.”
What Are The Chances?
Economic data and market conditions change on a daily basis, so the best forecasters can do in terms of predicting a recession is estimate the likelihood of one happening sometime in the near future.
On Jan 22, Morgan Stanley analyst Ellen Zentner pegged the chance of a U.S. recession in 2016 at only 20%.
Bond analyst Marty Fridson calculated in January that the high-yield corporate bond market is pricing in a 44% chance of a U.S. recession within the next year.
Bank of America analyst Martin Mauro recently upped his 2016 U.S. recession probability to 25%.
The New York Fed and Cleveland Fed estimate the chances of a recession in the next 12 months at only 5% and 6.1%, respectively, based on current Treasury yields.
The bottom line
Despite overwhelming fears in financial markets, a number of experts still feel that the chances of a U.S. recession in 2016 are less than 50/50. The stock market, on the other hand, is already pricing in a 50% chance of a recession, according to analysts at Morgan Stanley and Bank of America. If these analysts are correct, the 2016 stock market selloff could ultimately prove to be yet another example of emotional market overreaction rather than an indication that a U.S. recession is imminent.