Business Cycle Prediction

Macro indicators & US Recession risk

04 Jul 2022

Today, as we observe the Fourth of July holiday in the U.S, we hope you have a happy and safe celebration.

There has been a lot of recent talk about the possibility of a global recession, as central banks around the world raise interest rates aggressively to reduce demand and bring inflation under control. In the United States, GDP growth in the first quarter of 2022 was negative, and if Q2 growth also turns out negative, then the U.S would technically be in a recession already. Early signals suggest that Q2 growth will likely be positive but there is a lot of uncertainty.

Unlike today's low unemployment and high consumer demand, a global recession would be accompanied by lots of people losing jobs and spending less money on goods and services. This means lower earnings for businesses and their shareholders, like yourself. Not all businesses would be affected to the same extent, so it makes sense to shift dollars within a portfolio towards companies that might be more resilient in a recession. A good question to ask, then, is what are various indicators telling us about whether the U.S is in a recession and, what is the likelihood of a U.S recession in the near future. 

Today, our team uses three broad categories of macro indicators to get a clearer picture of the states of the economy and financial markets: (i) indicators that tell us where we are currently in the business cycle; (ii) indicators that tell us where in the cycle we are likely to be in a year; and (iii) indicators that tell us how volatile financial markets currently are.

First, we take snapshots of the current state of the economy using purely real economic data i.e., non-financial data that is adjusted for inflation. We pay particular attention to how much households are spending on durable goods like washing machines and refrigerators. People tend to hold off on these kinds of purchases when they are worried they might lose their jobs. This information is useful for telling us how likely it is that we are currently in a downturn (it's weird but technically we can only confirm in hindsight whether a recession has started or ended!). As with what real-time Q2 GDP estimates are showing, our models suggest that the US economy is likely not currently in a recession (see chart below).

Next, following work by U.S Fed economists, we use a combination of unemployment, inflation, term premia — the extra cost of borrowing over longer horizons, and credit premia — the extra cost of borrowing that less-than-stellar borrowers pay, to predict the likelihood of a recession twelve months from now. This model appears to do a decent job of matching recession data historically. As you can see in the chart below, the likelihood of a recession in the near future is estimated to be currently relatively high, above 50 percent. Remember that this is an estimate. It is impossible to say for sure whether there will be a recession soon. Macroeconomic forecasts are notoriously inaccurate. Indeed, we got the call wrong last year on how high and persistent inflation would run. 

Finally, while we work hard not to be governed neither by greed nor fear, we are paying close attention to short-term market volatility to get a sense of tail risk —the unlikely risk of large losses. Today, this measure is currently above its historical average yet pales in comparison to the global financial crisis of 2008-09. Overall, this points to higher-than-normal volatility and calls for a cautious approach to allocating dollars in our portfolio.   

Xantos Labs ("Xantos", "XL") is an SEC-registered investment adviser.

The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. The views expressed here are those of the authors and not necessarily those of Xantos. Charts and graphs provided herein are for illustrative purposes only. Nothing contained herein constitutes investment, legal, tax, or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially and should not be relied upon as such. XL and its affiliates may have positions (long or short) or engage in securities transactions that are not consistent with the information and views expressed in this document.

Diversification does not eliminate the risk of experiencing investment loss. Past performance is not a guarantee of future performance.

The information in this document may contain projections or other forward-looking statements regarding future events, targets, forecasts, or expectations regarding the strategies described herein and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and they may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.

Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight. Hypothetical performance results are presented for illustrative purposes only.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor. The factual information set forth herein has been obtained or derived from sources believed by the author and XL to be reliable, but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision.

Xantos may provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which has no control. In no event will XL be responsible for any information or content within the linked sites or your use of the linked sites.

Ready to get started?

app_store google_play
xantos-logo Get the app