Recession in 2023? A Shorthand Approach
If 2023 experiences a recession, it may be the most broadcasted recession in modern history. A quick Google search of “2023 Recession” yielded 227 million results! No one can possibly retain every available data point and forecast. So instead, we each create our own narrative for why there will or will not be a recession this year. Sometimes it’s a hard data point; other times it’s through a story or anecdote. The shorthand approach is not intended to be exhaustive, so you will note important economic news such as debt ceiling negotiations, inflation, commercial real estate, and quarterly earnings are not addressed here. With that, here’s one shorthand list of why we may see a recession, why we may not, and three takeaways in 2023.
Why 2023 may see a recession:
The yield curve is inverted.
When the 10-Year Treasury Yield is lower than the 2-Year Treasury Yield, a recession has typically followed. See the chart below in which shaded areas indicate a recession after the line breaks the 0 mark.
Capital has a higher cost and more challenging to acquire.
A project expecting 8-10% returns looked attractive when access to capital was easy and interest rates were low. Today, that same project has a higher cost of capital as financial conditions have tightened. Whether a Fortune 500 CFO, small business owner, or “household CFO,” higher costs and tighter access to capital may naturally slow down spending and investment across the economy.
Predictions of recession may lead to self-fulfilling prophecies.
If people are told it’s likely to rain today, they will take an umbrella or rain jacket. If people are told we are likely to have a recession, both businesses and consumers may similarly take precautionary measures to reduce consumption and spending. If many people behave in this same way, the EFFECT of predicting a recession could very well lead to the CAUSE of an actual recession.
Why 2023 may NOT see a recession:
The labor market remains strong.
A key ingredient for any recession is a weakening jobs market. That ingredient is currently absent as the labor market remains robust to this point. Unemployment is near all-time lows, and the labor force participation rate continues to increase, meaning more people are joining the work force and finding employment. With 9.6 million job openings as of March 31, there is still runway for unemployment to remain low.
Real GDP continues to be positive.
The Bureau of Economic Analysis (BEA) reported first quarter 2023 real GDP growth of 1.1%, which was the third quarter in a row with positive real GDP growth. The Atlanta Federal Reserve GDPNow model predicts 2.9% real GDP growth for the second quarter as of May 17. Recession predictions started in earnest for second-half of 2022, and yet the US economy continues to remain resilient.
Consumer spending remains strong.
Consumer spending accounted for 68.4% of first quarter 2023 GDP according to the St. Louis Federal Reserve’s FRED economic data base, so it’s important to monitor for underlying trends in the economy. Thus far in 2023, spending as measured by the Personal Consumption Expenditure (PCE) report has stayed elevated, though growth is moderating. According to Live Nation Entertainment, US concert attendance is up 24% this year compared to 2019. And the Wall Street Journal reports the average resale price for concert tickets on SeatGeek has doubled since 2019. Higher concert attendance while absorbing higher ticket prices is an anecdote type example suggesting consumers are not exhibiting recession-like behavior. As JP Morgan’s Dr. Kelly wittingly stated this year, “when the going gets tough, Americans go shopping.”
Key takeaways – recession or not:
A recession is not a depression.
A recession simply means output is less today than the prior period. Two steps forward, one step back appears everywhere in finance and economics, whether it’s an individual’s balance sheet, an company’s earnings, or the economy itself. A step back is a normal part of the market cycle.
The market is not the economy.
The S&P 500 delivered positive returns in 2020 and negative returns in 2022. Yet the real economy froze in 2020 during the Covid-19 pandemic, overall performed well last year. Whether there is a recession in any given year may not be indicative of the market’s current performance. Remember, the market is a leading indicator as compared to the real-time measures of the economy.
Bonds offer compelling yields.
Bonds offer comparable or higher yields than the earnings yield of S&P 500 companies. Why this matters:
If long term stocks average 8% annual returns, bonds average 2%, and an investor needs 7% to achieve their financial goals, then the investor needs to allocate over 80% in stocks to attain their goal. However, change the equation to bonds averaging 5% annual returns, and the same investor only requires about 60% in stocks to reach the same goal. While oversimplified, the concept holds true – investors may have an opportunity to take less risk while striving for same results due to today’s higher bond yields.
Hearing clients’ perspectives on the economy provides valuable insight to help shape our own economic and market views. We love to hear your feedback. What makes your shorthand list that indicates recession or not this year?
Andy Michael, CFA
Portfolio Manager
