Are We Headed for Recession?

January 19, 2016 at 08:48 AM
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Talk of an impending recession has blown up since the start of the year – largely thanks to the abysmal performance of the stock markets.

The S&P 500, which just experienced the worst two-week start to a year ever, is down 8% since the year began.

According to Schwab's chief investment strategist, Liz Ann Sonders, there have only been five other years since 1928 when the index fell by more than 5% in the first 10 trading days of the year.

Stock activity over the past two weeks has fueled talk of a weakening U.S. economy and the possibility of a recession.

In a recent note to its clients, the Royal Bank of Scotland said: "Sell everything except high-quality bonds."

"We have been warning in past weeklies that this all looks similar to 2008. We dust off our old mantra: this is about 'return of capital, not return on capital.' … In a crowded hall, exit doors are small. Risks are high."

RBS thinks China could be the crisis point for this recession, as the Lehman Brothers collapse was the catalyst for the 2008 financial crisis.

Not everyone is convinced of RBS' prognosis, but there are several other big U.S. firms predicting a recession over the next one to three years.

Last month, JPMorgan put a 76% chance of a recession within the next three years, with a 25% of chance of a recession within the next 12 months. 

Meanwhile, Citigroup's 2016 outlook warned that there is 65% chance of a U.S. recession in 2016, based on the fact that the U.S. economy enters its seventh year of expansion following the 2008-09 crisis.

Citigroup looked at data on the length of economic expansions in data from 1970 to 2014 across the U.S., U.K., Germany and Japan.

According to several market experts, much of the talk about a recession seems overblown.

In her latest commentary, Schwab's Sonders said that "every predictive recession model I have studied still suggests a low risk of recession."

She goes on to say that if the U.S. were in a recession or heading toward a recession, it would be the "first time in history" that the leading indicators did not roll over and provide ample warning.

"We are in a manufacturing recession, but at this point, the much larger services segment of the economy is showing sustained growth," Sonders writes. "Historically, if the annual average of industrial production is down for an entire year, weakness spread to the broader economy. We have yet to see that kind of weakness, but it's on our watch list."

PIMCO global economic advisor Joachim Fels also acknowledged that a manufacturing sector recession and correction was spilling over into the broader economy, during a segment on CNBC's "Squawk on the Street."

However, he also thinks that – because of decent job growth, low energy prices and a strong residential construction sector – the economy will reaccelerate.

"I think we can still see something like 2% growth in U.S. this year, and therefore I think the markets are clearly exaggerating," he told CNBC.

While there are some that are very clearly worried about China, Bob Doll argues the U.S. economy is "relatively insulated" from China's woes. 

The Nuveen Asset Management equity strategist says in his weekly commentary that 2015 U.S. exports to China were $118 billion, which represents less than 0.66% of U.S. GDP. 

"As such, we think there is virtually no chance that the U.S. could 'import' recession from China," he writes. "If anything, cheaper Chinese goods could represent a form of economic stimulus."

Sonders also points out that low oil prices usually help fuel the U.S. economy.

"If a recession is coming, it would also be the first time in history it was preceded by a crash in oil prices — more often than not, it's a surge in oil prices which helps trigger a recession," Sonders writes. "As a consumption-oriented economy, U.S. growth is ostensibly helped by lower energy prices."

Phil Camporeale of J.P. Morgan Asset Management thinks the markets may be exaggerating the risk of recession. "This market is pricing in way too much of a recession risk than we believe," he told CNBC. "Right now the S&P is about 1,900. Usually in a recession, you get a 30% decline from the high which would put the S&P 500 at 1500. If there's no recession we should probably make new highs this year, which is probably about 2,200. Right now we're right in the middle of that – about 50% recession risk. That is way too much."

Two recent surveys do show that recession fears are rising higher than they have been in recent years.

Economists in a Bloomberg survey are saying the odds of a recession are the highest since 2013.

According to this month's Bloomberg survey results of 36 economists, the median probability for a U.S. recession in the next 12 months jumped to 19%.

In addition to being the highest since February 2013, Bloomberg also says this is up from three straight months at 15%.

The survey then asks the economists which year they think a recession will occur, and the median response was 2018, unchanged from the previous two months. 

Meanwhile, the latest CNBC Fed Survey showed that the chances of a recession in the United States are at their highest levels since the fall of 2011; respondents see a 28.8% chance of recession in the next 12 months.

The survey, which typically includes responses from around 40 of the nation's top money managers, investment strategists, and professional economists, showed recession fears rose for the sixth straight time among respondents and the second highest in the five-year history of the question.

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