Episode 7 – Are We in a Recession?

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Hello, everybody. Thank you for tuning in to Market Perspectives, a Mercer Advisors podcast where we provide a real-world, data-driven perspective on markets, on the economy, and on investing. I’m your host, Don Calcagni, chief investment officer with Mercer Advisors.

Today, I’m going to provide some commentary on this question that we’re receiving a lot from clients around whether or not the US economy is in a recession. And I think that’s a fair question. It has certainly been a tumultuous couple of s economically.

We’ve seen significant inflation. We’ve seen the Federal Reserve respond to that inflation with some pretty dramatic increases in interest rates over the past 18 months or so. I think it’s just a natural question that we perhaps feel like the economy is not doing well, and perhaps we’re seeing that in our own personal lives, perhaps at work, or perhaps financially. We are perhaps struggling more than we were perhaps a couple of years ago, and so I think it’s a natural question to ask. But staying true to the spirit of this podcast, I think it’s important to back up and actually look at some real-world data.

And when we do that, when we back up and look at data, what we see is that the US economy, by any metric, is not in a recession and probably not by a long shot. So if we just look at GDP growth for a moment, GDP growth is currently at around 2% year-over-year. That’s positive. So a recession, by definition, would be negative GDP growth.

And the technical definition of a recession from the National Bureau of Economic Research–

they are the committee that ultimately determines whether or not we are in a recession–

is they are looking for a broad-based decline in economic activity across a range of sectors, industries, and certain metrics.

And the reality is the NBER has not declared that we’re in a recession. And when we look at the same data that NBER would be looking at to make that determination, the obvious one is GDP growth. GDP growth is still positive.

If we look at unemployment, unemployment is still near 50-year lows. It’s currently at 3.7%. That’s pretty low.

Now, we can debate. Are there different ways to measure unemployment? Yes, there are.

There’s lots of ways to measure unemployment and underemployment and workforce participation. So I’m just giving you the headline unemployment rate is about 3.7%. That’s the same metric that we’ve been using for many decades.

Inflation. Inflation has come down quite significantly. It peaked in June of last year, June of 2022 at around 9%. And just last week, we received the updated CPI report from the Bureau of Labor Statistics. And it’s come down to 4% year-over-year.

So we’re seeing inflation come in. To be fair, inflation is still running a little hot in a couple of areas, shelter among those. So again, but by any measure any objective measure headline CPI has come down quite significantly over the past 12 months, no doubt in response, I think, in part to the Fed’s pretty aggressive interest rate hikes.

If we look at things like the stock market, the S&P is up almost 20% year-to-date. Now, to be fair, most of that gain is driven by a very, very small handful, probably five or six, maybe seven technology stocks. But the market overall is up this year over and above where it was last year. And market volatility has currently come down, so we’re not seeing these huge swings in the equity markets at the moment. So again, I’m just highlighting some of the key metrics that we would look to that would perhaps give us some indication that the US economy is in trouble or perhaps heading towards a recession.

There is one metric that I think is very important, and probably says more about how we feel about the economy than anything else. And that is the University of Michigan’s consumer sentiment index, which is currently at about 64.4.

So just to give you a little bit of context, that’s pretty low. That is near historic lows.

It’s not quite at the bottom. It’s been lower at certain points in the past, but that is below, far below its average and far below where it’s at most of the time. So if we look at the 2/3 range for the consumer sentiment, what we see is that we are well below that. Most of the time, consumer sentiment is coming in somewhere in the 80s.

Now, we’re at 64.4. So it’s pretty low, which I think–

the way I read that is that we are feeling perhaps a bit melancholy about the economy. And I think that probably has more to do with things that I’m not an expert in.

I sense that it has more to do with the partisanship in our country at the moment. I think it probably has more to do with that, and perhaps just the headlines. And I think that’s totally natural.

We are all psychological beings and I think we all pay attention to the news. And we all have our views and opinions on who should be governing the country, control Congress, and the White House, and so on and so forth. And so I think part of how we’re feeling about the economy is being picked up by that University of Michigan consumer sentiment survey, which has been pretty low for quite some time.

But again, I think the data tells us that the economy is not in recession, and it doesn’t really look like that. We’re heading towards a recession. And to be fair, there’s a lot of debate around the future direction, the future course of the US economy. You can get 10 economists in a room and ask them if they think the US economy is going to be in a recession in the next 12 months, and they’re probably going to give you 20 different answers. So I don’t know that you can really get a straight answer.

What I would say–

and this is something that we track very closely at Mercer–

is what economists, on average, believe. The odds are that the US economy will dip into recession over the next 12 to 18 months. And so we closely follow Moody’s analytics. Mark Zandi is their chief economist.

And we closely follow a lot of their work.

And I think if we were to survey them and I’ve heard them say this, I think most of the forecasts put the odds of a recession somewhere in that 35% to 50% range, at the moment, sometime over the next 12 to 18 months. And I could see that happen. I think we can make an intellectual case why that might happen.

We are seeing some softening in job creation. The Federal Reserve has raised interest rates, in my view, very quickly, and probably they’ve raised them too high. And I think, ultimately, that’s going to come back and have a negative impact on the US economy.

To be fair, I have been wrong when it comes to that belief over the past year and a half. I believed that the Fed was moving last year far too fast and moving far too high. And I thought, and I know many other economists believed as well, that the Fed was going to tip the US economy into recession. That did not happen.

Trying to predict the future course of the US economy, just trying to predict markets, I would argue a fool’s errand. It is infinitely complex. There are a lot of factors that influence the future direction of markets and the economy. So any forecast that one makes with respect to a recession, a looming recession should be undertaken with an exceptionally high degree of humility.

But again, getting back to the question, are we in a recession? Well, no. The data says we’re not in a recession. Are we then perhaps heading towards a recession?

Well, that is a game of probabilities, looking at the data and attempting to divine what’s going to happen, given certain trends that we’re observing in economic data. And again, like I said, I think most economists, macroeconomists who follow these things, anywhere between 35% to 50%. Some of the real bearish economists might go as high as 60% odds of dipping into recession over the next 12 to 18 months, but those are really outliers at the moment.

And I think what this really tells us is that over the past couple of years, the US economy had unbelievable momentum coming out of COVID. And the Fed’s interest rate hikes have certainly dented that momentum. They’ve slowed that momentum.

But it is interesting that we still see positive GDP growth. We still see positive jobs growth. I think the Fed’s number–

not the ADP private payrolls number, but the Fed’s number that came in last week or the week before that was 209,000. That’s still 209,000 jobs created for the month, and that’s pretty significant. That’s just about equivalent to the increase in the workforce over that particular month.

So I think the economy must have had and certainly did have, in retrospect, really powerful momentum coming out of COVID. And so the Fed’s interest rate hikes certainly moved too high too fast, but they’ve certainly slowed that momentum. But at the moment, it does not look like that those interest rate hikes have thrown the economy into reverse.

Again, the future is ultimately unknowable, remains to be seen. There could still be another shock to the economy out there, perhaps another shoe to drop. It’s one of the things that the team here at Mercer Advisors we spend a lot of time monitoring, what’s happening in the financial system, monitoring interest rates.

Back in March, for example, we had a mini-banking crisis flare-up among some of the smaller regional banks. And right away, we did a quick analysis of bank balance sheets to see what the system looked like. And I think at the moment the banking system looks relatively well capitalized.

So a related question that I’ve been seeing is, gee, what’s going to happen to the banking system given that the Fed has raised interest rates so quickly and so high? And again, when we look at the data, when we look at bank liquidity ratios, when we look at their balance sheets, we’re not seeing any evidence at the moment that there’s any real stress in the financial system. But again, like I said, the future is ultimately unknowable. There could be something else that could impact the economy.

And for that reason, the question is, OK, then what do we do with that information from an investment perspective? How should we think about our portfolios, given the fact that the future is ultimately unknowable, that there are an infinite number of factors that drive markets, that drive the economy? Well, and I know it sounds a bit trite, it is to diversify our portfolios.

It’s to make sure that we have a written financial plan in place to help govern how we think about our portfolios, that we understand why are we investing. What are we investing for? What does success look like to us personally?

So building globally diversified portfolios and always making sure that we have a suitable emergency reserve in place, in the event of an unfortunate job loss or perhaps a medical emergency that’s perhaps not covered by insurance or something like that, all of that is paramount. That’s the real takeaway from this discussion, from understanding the economy, from understanding markets. There are a lot of things that drive markets that even the experts, folks who follow these things, folks who have made a career of studying markets, things that they themselves fail to predict accurately, things that they themselves ourselves oftentimes just don’t understand.

There are many, many economists who have really been befuddled by the performance of the US economy over the past two years given the Fed’s very aggressive interest rate hikes. And yet, here, we are. We still have positive GDP growth.

So I think trying to connect an investment thesis, a short-term investment thesis to what’s happening in the economy, that is a fool’s errand. I think that is exceptionally dangerous and a very, very big threat to our financial health if we were to try to do that. So our advice to clients is to work closely with your trusted advisor, make sure you understand exactly what you’re investing for. If you don’t know what success looks like to you personally, you’re never going to recognize it when you get there. So you want to make sure that your portfolio makes sense.

Forget trying to beat markets or trying to outperform your next door neighbor or your friends at the country club. Your portfolio should be focused on shoring up your family’s economic freedom, your financial security, based on your personal goals and objectives. That’s really the goal of our portfolios, is to deliver long-term, inflation-adjusted returns so that we can achieve our objectives. And one of those objectives needs to be to manage the risks that are inherent in the economy, to manage the risks that are inherent in markets and a well-designed, well-diversified portfolio.

It’s never going to make your financial plan bulletproof, but a well-designed, well-diversified low cost portfolio is really critical to helping you navigate the uncertainty that is the financial storms that are out there in the economy all the time. Even when times are good, there are always risks out there in the US and in the global economy. So we deal with those risks through very broad diversification, focusing on high quality companies at a reasonable price, investing in high-quality, high credit quality, short-term bonds, hiring high-quality third-party asset managers–

the mutual funds, the ETFs, the private equity managers that are in your portfolios. It’s really just making sure we’re selecting the absolute best managers possible to work with when implementing our portfolios.

So that’s it for today. Thank you for taking a few moments to listen in. And as always, if you have any questions, please feel free to reach out to your advisor here at Mercer Advisors. Thank you for listening, and thank you again for all the trust and confidence that you place at Mercer Advisors.

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