Assessing the Likelihood of a Recession

Recession fears are running high

Three out of every four Americans said just two months ago that they feared a recession would hit this year, and more than half were concerned that they would lose everything if that happened. In April, the Conference Board estimated a near-99% probability of a recession in the next 12 months.

On May 29, The Conference Board's principal economist, Erik Lundh, warned that the latest set of data indicated that a shallow recession is underway. That week, U.S. consumer confidence tumbled to its lowest level in six months amid signs that the labor market is cooling.

There are some significant disparities between what people think is happening and what's actually happening. In fact, a recent poll from Ipsos suggested many people think their economy is in a recession, but few economies agree.

The latest Ipsos Global Inflation Monitor found that more people in 26 of 29 countries think their country is in a recession than think it isn't. Nearly two-thirds of those surveyed expect inflation to keep rising over the next year, and one-third expect their disposable income to decline.

Consumers might be fearing the worst – but market and economic conditions say the worst is unlikely.

Extreme pessimism among investors

Consumers aren't the only ones who are pessimistic. In fact, investors are the most pessimistic this year than they have been in a long time. Bank of America's Global Fund Manager Survey for May found that growth expectations are at the lowest level year-to-date, with investors boosting their cash balances as they adopt a more pessimistic view on growth.

Almost two-thirds of fund managers expected the economy to weaken, although 63% still said U.S. policymakers will be able to engineer a soft landing. Only 27% of fund managers predicted a hard landing.

The biggest tail is a recession, cited by 33% of fund managers, and high inflation and hawkish central banks were chosen by 29% of respondents. Almost half of fund managers saw commercial real estate as the most likely source of a credit event.

But despite that pessimism, investor allocations to stocks remain at a five-month high, led by a broad-based rotation from commodities into technology stocks, the highest reading in 17 months. Going long on big tech is widely seen as the most crowded trade.

Recession-resistant sectors and stocks

As advisors and investors weigh the widespread pessimism versus the hard economic data, there is much to consider.

This might be a good time to migrate part of the portfolio toward recession-resistant sectors, which include healthcare, consumer staples, utilities, energy, discount retail, do-it-yourself retailers, and auto-parts retailers.

Other stocks that could hold up well during a recession include mega-cap technology names. In fact, many investors have already been treating most big tech names as recession-resistant stocks, and a recent survey offered some insight into why that might be happening.

The latest Markets Live Pulse survey found that over 40% of market participants expect the highest returns this year to come from buying quality stocks with sizable profits and selling stocks that run against that trend. This could be why companies like Microsoft and Apple have surged this year, with Microsoft gaining 39% year-to-date and Apple up 42%.

The rush back into big tech is coming at the expense of traditionally recession-resistant sectors. Thus, while it may make sense to start buying into more recession-resistant industries, advisors and investors shouldn't ignore big tech, albeit with caution, as the sector may become too expensive.

More specifically, fund managers surveyed by Bank of America reported a sizable rotation out of commodities, which are traditionally considered recession-resistant, and into technology.

What's driving these market shifts?

It's a good idea to monitor trends when consumers and investors are extremely pessimistic despite the positive data. One problem is a lack of clarity on what the Federal Reserve is planning to do with interest rates, which is giving the markets the jitters and boosting growth stocks.

While the broad trend is a rotation into big tech, advisors may want to remind investors that the sector could slow in the event of a recession. But big tech's momentum suggests a whole-hearted commitment to either technology or recession-resistant sectors like commodities may be better replaced with a mix of holdings that will fare well in a recession.

Thomas Young is running for Utah State House District 40. Outside of politics, he is an economist who builds models, researches the economy, advises on public policy, speaks at conferences, and enjoys thought leadership.

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