US recession talk has all but vanished lately but high-flying stock markets may be badly underestimating a risk that remains all too real, according to a new study authored by State Street Associates and MIT.
The authors of the paper, A New Index of the Business Cycle, created an index based on four economic variables – industrial production, nonfarm payrolls, one-year stock returns and the slope of the yield curve. Since 1916, this index has been a reliable recession indicator, with high readings indicating an increased likelihood of an imminent downturn.
For example, when the index topped 60 per cent, a recession occurred 61 per cent of the time within six months; when it exceeded 70 per cent, the frequency of recessions was 70 per cent; and when it exceeded 90 per cent, recessions followed 91 per cent of the time.
In November, the value was 76 per cent – that is, current economic conditions have historically been associated with recession 76 cent of the time, and with robust growth only 24 per cent of the time.
Most economists would disagree. A model by Bloomberg Economics estimates the odds of a recession within the next year to be 26 per cent.
Equity markets are even more relaxed; according to Pictet fund manager and bear Julien Bittel, US markets are pricing in a “ludicrous” 2 per cent chance of recession, indicating investors are very confident right now – too confident, if the State Street/MIT study is right.