Recession 2023

Historically, an economic recession has been seen when growth for two consecutive quarters was negative. 

However, that is not the official definition of recession, being the NBER (National Bureau of Economic Research) the official body in charge of defining when each economic cycle begins and ends. 

According to the NBER, a recession involves "a significant drop in economic activity that spreads across the economy and lasts for more than a few months." 

To determine the recession, the NBER monitors six economic variables that correspond to four primary categories: production, income, employment and spending, and is what is known as PIES. 

In the following image we observe the evolution of these variables in recent years. 

When they are all in the red, that is when the recession becomes official.

Although the recession has not become official, in the real economy and among the population there is a feeling of economic recession since 2022. 

In the following image we can see the quarterly evolution of the GDP. It is observed that Q1 22 and Q2 22 were negative, and although it could be a reason to have made the recession official, the NBER, according to its indicators, did not.

Currently in the market there are two contrary opinions. 

On one hand, those who believe that the recession will occur in a matter of time, during this year. 

On the other hand, there are investors who believe that we will exit the bear market without entering a recession.

From a probability point of view, these are very high for us to have a recession this year, as we see in the following image:

There are also several very important economic indicators that are very deteriorated, and that have historically, in similar situations, preceded recessions. 

For example, in the following chart we see the Leading Indicator index, which shows how when it has fallen from -4%, the economic recession has occurred. 

It is currently close to -9%.

This other one is the Philadelphia Manufacturing Indicator, which has also broken the level where recession has historically materialized:

In the following image we see the evolution of credit conditions, currently also pointing towards a recessive scenario:

Also the Unemployment Rate, currently rising, indicates that the recession is close, although in this case we should see a break up in its 12-month average:

In the following image we also see an indicator made up of a compendium of economic indicators. 

Similarly, the recession signal activation limit has already been given.

However, despite the fact that the odds are in favor of a recession and that most economic indicators are warning us of it, the market, the S&P500, is telling a different story. 

In the following image we see how the S&P500 has behaved during Bear Markets, and how it has evolved in recessionary or non-recessionary environments. 

The dotted line shows the historical evolution of the S&P500 in a non-recession environment, while the thick green line is when there was a recession.

For now, the market appears to be heading higher, pricing in that there will be no recession, although that could turn around quickly, especially if the S&P500 breaks down the 4,000 level.

What would happen in the market if there was a recession? 

If we focus on the most likely scenario, we are going to see what has happened historically when the recession has become official. 

For one side, if the recession is confirmed, the S&P500 will most likely make new lows. 

In the following table we look at historical recessions and in all of them, the market made lows during the recession, not before.

In this other image it is better appreciated. 

It is observed that the months prior to the recession, the S&P500 behaves quite erratically, but once it becomes official, the market goes in search of those new lows, occurring in the first 3 months once it becomes official.

In the image below we can see the returns of the S&P500 during recessions. 

It is observed that the first third of the recession is when the market tends to behave negatively, rebounding from lows.

The following image shows how the S&P500 performs during the recession and in comparison with the evolution of corporate profits (red line). These recover much later than the market itself, which does so in the first 3 months.

Another key factor this year will be the FED Pivot. It is expected that the FED will make its last rate hike in next meeting in May, and it is estimated that from June starts to lower rates.

Recession and rate cut cycle have historically been closely linked, cutting 300 basis points in the first 12 months after the recession started. 

Historically, once the Fed begins its rate cutting cycle, a recession is imminent. 

This can be seen in the following graph:

In short and to finish. We are currently not in a recession and the S&P500 is discounting it in this way up, in a bullish scenario that could continue to the surprise of most investors. 

But if economic conditions continue to deteriorate and the recession becomes official, the S&P500 will most likely resume the downtrend in search of new lows.