(Bloomberg) — It wouldn't take much to look at the performance of markets these days and draw the conclusion that investors deem a U.S. recession as all but inevitable. A deeper dive finds a more benign scenario.
Yes, global equities fell within points of a bear market, relative yields on junk bonds have blown out to the highest in four years and the price of oil has collapsed along with most other commodities. While U.S. stocks haven't been immune from the downdraft, history shows there's only about a one-in-three chance that America's economy will shrink within the following 12 months based on the signal they're sending.
Maybe even more telling is the response of big investors when asked to interpret the signals that the market is sending. Rather than buying into the recession scenario, many such as BlackRock Inc. Chief Executive Officer Laurence D. Fink, whose firm manages $4.6 trillion, are surprisingly sanguine. The consensus is that markets have overshot relative to the fundamentals.
"Markets tend to be a lot more volatile over time than the economy," said David Joy, the Boston-based chief market strategist at Ameriprise Financial Inc., which oversees $766 billion. "The U.S. economy has enough strength to it that we'll avoid a recession. The chances of it happening this year are not zero, but I would say it's no better than one-in-five or one-in- four."
Recession odds
Looking at nothing but data, it's not obvious that the U.S. recovery is poised for doom. The unemployment rate sits at a seven-year low of 5 percent, gross domestic product is forecast to grow at a 2.4 percent rate in 2016, and Goldman Sachs Group Inc. is saying this will be a "reflationary year" even as measures of price increases show little to no gains.
The median probability for a U.S. recession in the next 12 months stood at 19 percent in this month's Bloomberg survey of economists. While that's the highest since February 2013, the median response of 36 economists put the likeliest year for a contraction as 2018, unchanged from the previous two months.
At the same time, headline moves for American stocks in 2016 have been enough to shake confidence. Among other things, the worst two-week start to a year on record destroyed more than $2 trillion of equity value, a hit that in and of itself could affect consumer behavior. Futures on the Standard & Poor's 500 Index fell 0.4 percent at 9:26 a.m. in London.
Going by history, the signs aren't conclusive. Down as much as 12 percent from its high, the S&P 500 just had its 42nd correction of 10 percent since 1927. Of the previous, only 13 came within a year of a two-quarter contraction in gross domestic product. Goldman Sachs looked at shares of companies that get most of their sales at home and finds them beating overseas-facing counterparts by one of the widest margins since 2007.
There's another way of looking at equities that has proven prescient in calling recessions past: rolling 12-month returns in the S&P 500, adjusted for inflation. As of Friday, the benchmark gauge for American equities was down 5 percent on that basis. While among the biggest such losses since 2009, it's 4 percentage points away from the average before economic tops were hit, according to Leuthold Weeden Capital Management LLC data.
"I'm not convinced on a recession call," said Doug Ramsey, chief investment office at Leuthold Weeden whose bearish forecasts on equities have proven prescient. "If we do go down 25 percent on the S&P 500, then I would say, yes, we'll have a recession. If we bottom here, I think it's a much tougher call."
While last week's retreat in the 10-year Treasury yield below 2 percent struck fear into bulls, it's hard to argue the level is recessionary, based on recent history. The yield closed below 2 percent almost 60 days last year and spent most of 2012 below that level without portending a contraction.
'Digestion problems'
"The market may have some digestion problems, but I think over the course of the next year we'll see a higher market, global GDP is going to be around 3 percent, maybe not as high as the IMF sees but I'm not that worried," BlackRock's Fink said Friday in a Bloomberg Television interview from the World Economic Forum in Davos. "I believe this is a capitulation, not a bear market."
For the economy's sake, it better not be. Among the 20 percent drops that have hit American stocks 13 times since the Great Depression, 10 preceded U.S. recessions and only four recessions occurred without a bear market warning, according to data compiled by Bloomberg. At its worst level on Jan. 20, the S&P 500 needed to fall another 5 percent to meet the threshold.
