Why a Recession Isn’t Inevitable

An ugly word has been shooting around the media like it’s going out of fashion: Recession, usually defined as two back-to-back quarters of a shrinking economy.

Judging by recent headlines and rhetoric from experts, you’d think we are already there. But as with many things, the truth is more nuanced. To be sure, no one in their right mind wants to see a recession, as these periods of malaise usually coincide with higher unemployment and lower corporate profits.

While there are growing risks of a recession as the world economy slows, the chances a recession will take hold are lower in the U.S. and Asia than in Europe.

For now, what we have is a global economy in deceleration mode. “In a slowing economy, investors get anxious because that R-word may be right around the corner,” says Amanda Agati, chief investment officer at PNC Asset Management Group.

Where the fear comes from

The current worries aren’t just investor paranoia, however. First-quarter economic growth in the U.S.—the world’s largest economy—slowed to 3.5%, down from 5.5% during the last three months of 2021. Meanwhile, the Federal Reserve instituted its most aggressive interest rate hike in nearly thirty years this month, as part of its war on rising prices. Inflation recently soared to an annual rate of 8.6%, up from 5.3% in August.

A primary issue for investors is the Fed’s historic lack of skill in reducing inflation while avoiding a recession. “The Fed has never orchestrated a soft landing once after completing a tightening cycle,” Agati says. Indeed, the Fed’s inability to effectively get its timing right may be the biggest risk.

Still, there are many reasons for optimism. “We don’t see the probability of a recession in 2022,” Agati says. “We think the economy holds up,” She sees a mere one-in-three chance of a U.S. recession next year.

Overblown worries

That makes sense to a handful of other economy-watchers, who see many signs of strength among perceived risks that are probably overblown.

Sure, investors are alarmed by a weak stock market. So far this year, the S&P 500 index lost more than 20%, ushering in a bear market. Such a dramatic downdraft in the stock market could augur a recession. But it doesn’t always. In October 1987, stocks fell more than 20% in one day. There was no imminent recession. In late 2018, the same index retreated nearly 20%. Again, no recession followed. Similar, although smaller, declines occurred in late 2015, and the middle of both 2011 and 2012, again with no subsequent recessions.

Another likely phantom worry is the recent softness in the U.S. housing market. Sales of new homes in the U.S. dropped to an annualized rate of 591,000 in April, from 831,000 in January. While that doesn’t sound good, the slowdown likely won’t be prolonged or severe, experts note.

Over the last decade, home builders have constructed fewer houses than necessary to keep pace with population growth and the essential replacement of dilapidated structures. That means there will almost certainly be a bounce-back in demand for real estate. “It is universally agreed that we have a housing shortage,” says Jay Hatfield, CEO of Infrastructure Capital Management. “We don’t think housing goes into a death spiral.”

The homebuilding downturn likely means the U.S. economy will not grow as fast as it has recently. But that is different from a six-month-long contraction of the whole economy, which defines a recession. “We see a slowdown,” says Thomas A. Martin, Senior Portfolio Manager at Globalt Investments in Atlanta.

Hidden Bright Spots

Meanwhile, the job market looks vibrant. “Employment remains strong,” Martin says. The recent monthly employment report shows that the U.S. added 390,000 jobs during May, which exceeds the growth in the pool of active workers. And the unemployment rate remained steady at a historically low 3.6%.

That’s the opposite of typical recession news. In April 2020, the peak of the pandemic-led recession, unemployment jumped to 14.7% up from 4.4% the previous month.

Recessions tend to hit corporate profits hard. And yet Wall Street is forecasting the opposite. New York-based investment bank Goldman Sachs is currently predicting an increase in earnings for the companies in the S&P 500 index of 8% this year and 6% in 2023.

The U.S. energy sector is also booming. Consumers are contending with higher gas prices, but at the same time, the U.S. is exporting liquified natural gas to Europe to supplement now-reduced energy supplies following Russia’s invasion of Ukraine.

A Chinese recovery

Beyond the U.S., things look good too. China, the world’s second-largest economy and the driving economic force in Asia, looks likely to see a growth burst following temporary COVID-19-related lockdowns. The result of the restrictions was annual growth recently fell to 4.8% in the first quarter, down from 18.3% a year before.

“I expect growth to recover, and they have all the means to cut rates and use fiscal measures,” says Adrien Pichoud, chief economist at Syz Bank. He expects Chinese growth to be strong, meaning it won’t be in recession. He says after the post-lockdown rebound, the Chinese economy will likely stabilize with annual growth of 5% to 5.5%. “If China stabilizes it will be good for the rest of Asia.”

Real Concerns for Europe

Europe is a different story. The single-currency area known as the eurozone is currently benefiting from government assistance to help deal with soaring energy and food costs. That amounts to around 1% of GDP. “We’re not talking small numbers here,” Pichoud says.

However, the benefit of the subsidies will likely end by 2023, raising the risk of a European recession as the continent suffers from energy shortages. “We may face an environment where momentum is softer, and the headwinds of tighter financing raise the risk of recession,” Pichoud says.