What the stock market says about when to expect a recession

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Economists, investors and the Federal Reserve have been sounding the alarm for months that a recession could come later this year. But a growing chorus of experts believes a recession won’t happen until early next year.

Here are some of those recent calls:

Postponing recession forecasts is nothing new. Investors and economists predicted last year that the US could slide into recession in early 2023 after the Fed launched its aggressive rate hike campaign to curb inflation. As the economy proved more resilient than expected and the US has so far avoided a recession, the case for a recession in 2023 is crumbling. Bets accordingly have started moving further away.

We can halt the recession, says David Grecsek, director of investment strategy and research at asset manager Aspiriant. You gotta recognize that kid, we keep kicking this can, doesn’t it just mean we won’t have a recession?

Part of the reason it’s so hard to pinpoint exactly when a recession might start is that there’s a lag between the Fed’s rate hikes and when they begin to affect the economy.

Fed Chair Jerome Powell told Congress earlier this month that the Fed’s rate hikes will last a year and will change to accommodate their way through the economy. Given that it’s been over a year since the Fed started its rate hike cycle last March, in theory that means rate hikes could happen in full fast hold.

If the economy stays strong in the third quarter, there may not even be a recession, says Grecsek.

But we were a long way from that at the moment, he said.

What are the markets suggesting about the likelihood of a recession? It depends where you look.

The stock market, which entered bull market territory just a few weeks ago, has shown few signs this year that the economy could be headed for recession.

Small cap stocks, which are domestic economic whistleblower because by their exposure to financials and largely US sources of income have joined the tight rally in recent weeks. The Russell 2000 index, which tracks the performance of small caps, is up 6.8% this year.

That suggests investors’ risk appetite is increasing as the market breadth widens, even as mega-cap stocks continue to dominate the rally.

Another positive sign: the consumer discretionary sector of the S&P 500 indexes is up more than 30% this year, supported by strong economic data suggesting that Americans continue to spend briskly.

And Money market funds saw outflows for the first time since April in the week ending June 14, according to the Investment Company Institute. The outflow continued into the following week.

That’s another sign that Wall Street is starting to feel better about the economy because it suggests investors are taking cash out of classically safe money market funds and using it in the stock market, says Brian Mulberry, client portfolio manager at Zacks Investment Management.

Yet the bond market tells a different story: The New York Federal Reserves recession probability model calculates the probability of the US entering a recession in the next 12 months by tracking the spread of 3-month and 10-year Treasury yields. The model shows a probability of about 71% that the economy will enter a recession by May 2024. That is the highest value since 1982.

Two-year and ten-year Treasury yield curves also continue to invert, a phenomenon that has preceded all 10 U.S. recessions since 1955, according to the Federal Reserve Bank of San Francisco.

What does all this mean? There is no consensus on Wall Street about what the future of the economy holds, said Tim Courtney, chief investment officer at Exencial Wealth Advisors.

That’s because the past few years have been unique for markets and the economy due to the pandemic, resulting federal stimulus spending and the Fed’s aggressive clip of rate hikes, Courtney said. Combined with mixed data painting a murky picture of the health of the economy, investors remain undecided about what lies ahead.

There is no historical precedent to point to, he said. I don’t think the markets really know what to expect.

El Nio, a climate event that refers to the phenomenon of warmer surface water in the central and eastern Pacific, could affect more than just the weather this year.

Scientists at the US National Oceanic and Atmospheric Administration (NOAA) confirmed earlier this month that El Nio has surfaced and is likely to be strong this time.

That could pose a worrying headwind to US economic growth, says my colleague Samantha Delouya.

El Nio can create conditions that lead to more typhoons and cyclones in the Pacific Ocean, abnormal weather patterns even beyond the Pacific Ocean, and extreme weather events that can lead to natural disasters such as floods, wildfires and hurricanes.

In addition to the toll it could take on people’s lives and livelihoods, El Nio also poses a threat to the U.S. economy. Americans may end up paying even more than they’ve already paid for food in the past two years.

The airline industry, which has benefited from a travel boom in recent years, may experience more flight delays and cancellations due to inclement weather.

Read more here.

Monday: June ISM Manufacturing PMI. The U.S. stock market closes early at 1 p.m. ET for the July 4 holiday.

Tuesday: The US stock market closed on July 4.

Wednesday: FOMC June meeting minutes.

Thursday: June services PMI, May job vacancies and labor turnover survey and unemployment claims.

Friday: May’s jobs report.