What Are The Probabilities Of A Recession?

Includes: DIA, IWM, QQQ, SPY
by: Scout Finance


The economy has about a 70% chance of a recession just judging by the length of the recovery.

Buybacks and forward earnings are stalling out.

This could be the sign of a recession or just a minor dip in the economy.

Whenever anyone makes an economic prediction, there is a bit of uncertainty. In my estimation, the recession could be shallow or it could be deep. The chances of the economy skirting a recession are low. The reason why I promote the idea of a recession is because I believe the probability of a recession needs to go up in terms of what the market is pricing in. Investors deal in probabilities. This is why the market often prices in elections or earnings events ahead of time unless they reveal unexpected results by a large margin. I believe the Fed is 'on the moon' when it comes to economic projections, and the market is following this lead by heading towards all-time highs.

We have the Fed telling the market to not trust any negative data points. This absurdity makes me confused what will become of this situation. The Fed believes the economy is very strong yet refuses to raise rates because it knows the economy is weak. This is reminiscent of Marco Rubio saying he will win the nomination and then dropping out of the race after he lost Florida. The Fed may be trying to promote its own policies in a way to maintain its credibility. By doing this, it is making itself even less credible. If the Fed was saying the economy is weakening, then I would be much less bearish than I am now. The Fed is boxed into a corner because the economy is dictating it must not raise rates at all, but that would mean the cycle consisted of only one rate hike.

The part of the reason why I believe the weak data could finally cause the economy to roll over into a recession is the chart below. The economy now has about a 70% chance of going into a recession just based on the amount of years it has gone without one. This chart alone doesn't mean anything on an absolute basis, but weakening data points in 2016 are much more powerful than ones a few years earlier based on the general timing of the credit/business cycle.

This concept is explained by the chart of the ISM data below. Is the recent decline about to turn into a major swoon? I think it is more likely to be indicative of a recession than the decline in 2011 as the recovery was still in its beginning phases at the time.

Another example can be found in the S&P 500 forward earnings. The chart shows a dip in earnings in 2014 before recovering soon afterwards. This latest dip in earnings could be similarly shallow, but there is a strong possibility that it isn't.

Finally, I have a chart showing the buybacks of firms in the major market indices. Once again, there was a dip in buybacks in another time period (2012). This latest slowdown in buybacks could be another blip on the radar, but it is now in tandem with the chart above showing declines in earnings, so there is a much higher chance than a few years ago that this could be the beginning of a swoon.

I think most of the data is in a similar situation. It has swooned lower over the past couple of quarters. No one can guarantee what the future holds, but with the market near its all-time highs, it is likely it is mispricing the recession risk.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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