Dominoes: Recessions' History Guide

In mid-March, we penned a report on rising recession risk—which as a reminder, was prior to the "Liberation Day" announcement, and subsequent delays on the implementation of tariffs. Reading it again is a good primer for this report.

It has become no easier to gauge the trajectory of the economy since then; especially since a recession would be a "policy choice" of sorts. Barring more of a permanent backpedal, recession odds appear to us to be better than even. There are some offsets to tariff-related weakness in the form of deregulation and the possibility of an extension of 2017's tax cuts…but those are expected to be only partial offsets to tariff-related weakness. It's also the case that tariff front-running and "panic" buying is likely to flatter some economic reports in the near-term.

The longer that policy-related uncertainty remains elevated, however, the higher the odds of a recession. In this week's report, we're highlighting some key economic data that's come in since "part one" of this series, as well as looking at past recessions and market behavior around them.

As the dominoes fall

For backdrop purposes, the table below shows each recession in the post-WWII era along with the largest quarterly contraction in real gross domestic product (GDP) during each of those recessions. The ultimate doozy was the nearly 30% contraction during the early days of the pandemic.

In mid-March we unveiled (again) a dominoes visual we've been showing since the Global Financial Crisis era. Below is an update for the current cycle. We're keeping a close eye on the yellow dominoes, which highlight economic metrics that have weakened, but not yet fully fallen. Per the labor market, as reminder, we get the April jobs report this coming Friday.

Mixed dominoes picture

Staying on the labor market, there are some notable trends that bear watching. Shown below is full-time employment as a share of the civilian labor force. Alongside a significant decline in temporary help employment, full time employment has clearly rolled over. In the past, mid-cycle slowdowns and/or soft landings have not had a material impact on full-time jobs. Recessions, on the other hand, have historically been met with declining full-time work, as you can see via the recession shadings in the chart.

Full-time employment's rollover

We often talk about "animal spirits" as the best way to describe the psychological aspect of economic expansions—and the denting of those spirits that lead to recessions. On that note, the chart below shows the parabolic spike underway in the unemployment expectations component the University of Michigan Consumer Sentiment survey. Two-thirds of consumers now expect higher unemployment in the year ahead—very clearly in recession territory per the recession bars in this chart.

Consumers' unemployment fears spiking

Lastly on the labor-market front, below is a long-term chart of the unemployment rate, with recession bars. So often when economic slowdowns are underway, we're asked by investors why we should worry about a recession unless there is a significant rise in unemployment. Questions like that suggest the asker believes rising unemployment rates bring on recessions. In fact, it's the opposite cause and effect. As a highly lagging economic indicator, recessions have historically come first, and they ultimately bring on a sharply rising unemployment rate. In other words, a rising unemployment rate doesn't cause recessions…recessions cause a rise in the unemployment rate.

Unemployment rate = lagging indicator

Plunging "traffic" into United States

There are a couple of anecdotes worth analyzing given the tariff-related nature of this economic slowdown. Per a recent analysis by Torsten Slok at Apollo Global, container traffic from China to the United States is collapsing, as shown below. The consequences—recently being highlighted by many large U.S. retailers—are expected to be empty shelves and pandemic-like shortages for consumer and U.S. companies using Chinese products as intermediate goods. Inflation expectations are up as well given the significant number of product categories for which China is the main exporter into the U.S. market. It's expected there will soon be significant layoffs in trucking, logistics, and retail. With nine million people working in trucking-related jobs, and 16 million working in retail, the downside risks to the economy are significant.

Containers' about-face

Another anecdote is travel to the United States, with tourism being one of the largest U.S. export categories. Per data from Ned Davis Research, and shown below, tourist arrivals into the United States have dropped by nearly 12% year-over-year…and that's only data through March, which is obviously a pre-Liberation Day period. Outside of the pandemic lock-down phase implosion, that is the largest drop since the Global Financial Crisis.

Tourism's plunge

Stock market tie-ins

Shifting to the stock market, a key connection point between it and the economy is corporate earnings. Given we're in the teeth of first-quarter earnings reporting season, we're also in the throes of getting forward guidance (or lack thereof) from S&P 500 companies. Citi tracks earnings revisions, and as shown below, there has been a notable plunge in its Earnings Revisions Index, now down in (or at least close to) recession territory based on post-2000 history.

Analysts looking down on earnings

The series of charts below shows the history of S&P 500 returns around every post-WWII recession. The first section of charts covers the period since the National Bureau of Economic Research (NBER) formed its Business Cycle Dating Committee (BCDC) in 1978, at which point they formally (and publicly) began announcing recessions and their start/end points.

As such, the charts not only show how stocks performed between a year prior to recessions to a year after, they highlight the start and end dates (by month) per the NBER's declarations. (We batched the early 1980s double-dip recessions into one chart.)

Recessions and stocks post-NBER dating

In terms of the one-year lead-in, the 2020, 1990, and 1980 recessions, there was no notable weakness in stocks prior to the start of those recessions. On the other hand, there was notable weakness heading into the 2007-2009, 2001, and 1981-1982 recessions. On the other hand, notable advances in stocks were underway during recessions—not after they were already complete. (Caveat: although stocks bounced within the 2001 recession, it took another year for the true bottom to be found.)

The second series of charts covers the period before the creation of the NBER's BCDC. They also show that although there was mixed performance in the lead-in to recessions, the bottom in stocks occurred during recessions—not after they had concluded.

Recessions and stocks pre-NBER dating

Sector neutrality

Finally, we can look at sector performance during recessions (left chart below). For this analysis, we can only go back to the 1990 recession based on the history of S&P's sector classifications. As you can see, although defensive sectors like Consumer Staples and Health Care were typically near the top of the leaderboard, it was a mixed bag without a lot of consistency.

Since the S&P 500 suffered a near-bear market between February 19 and April 8, below we're also showing sector performance during prior bear markets (right chart below), of both the "near" (at least -19%) and full (at least -20%) variety. Here, too, you see a bias toward defensive sectors (like Consumer Staples and Utilities), but plenty of outliers.

Sectors in recessions/bears

Historical inconsistencies—along with massive policy-related uncertainty—is why we "neutralized" our sector recommendations in early April. That means we currently have no "outperform" or "underperform" ratings in place. The only other time we've done that was in the early part of the pandemic. Were it not for this unique policy-related uncertainty, we would have likely adjusted our ratings toward defensive sectors. But the whipsawing nature of day-to-day sector moves has moved us to the proverbial sidelines. This will change, but not quite yet.

In sum

To say this is a difficult economic and stock market path to navigate is the ultimate understatement. Given that a recession would essentially be a policy choice, the direction of policy from here is paramount to assessing rising or falling recession risk. Barring a more definitive pivot off the extremes of tariffs—both in place, and proposed tariffs that are in delay mode—we believe recession odds are better than even. Stocks began to discount a meaningful period of weakness for the economy courtesy of the S&P 500's near bear market that began in mid-February. The partial rebound that was unleashed when the Trump Administration announced the 90-day delay in the implementation of the Liberation Day-announced tariffs is testament to how much market volatility is—and will continue to be—driven by day-to-day policy announcements.

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