Skip to content
Search
By  Sébastien Page
Download the PDF

Special Topic: Can you trust recession forecasts?

Three special factors may help the U.S. economy avoid a recession.

October 2024, From the Field -

Key Insights
  • A simple three-factor model puts the odds of a recession over the coming 12 months at 92%, but it ignores some positive economic signals.
  • But simply adding two more variables—stock returns over the past year and the level of unemployment—brings the odds down to 11%.
  • The recession narrative ignores the “cushions” created by the pandemic normalization, aggressive fiscal spending, and the impact of preemptive Fed cuts.

The 12-month probability of a U.S. recession based on a simple three-factor model is 92%. Unemployment is rising, the Manufacturing Purchasing Managers’ Index (PMI) is at 47, and the yield curve is flashing red. This data configuration is reminiscent of early 2007.

Scary.

But it’s hard to trust these probabilities. The data are messy, and some signals are flashing green.

It’s not surprising, then, that there’s no consensus among economists on the likelihood of a recession among economists. In early August, many were arguing that the economy was at the “highest risk” of recession.1 Two weeks later, on August 19, Goldman Sachs lowered its recession risk forecast from 25% to 20% because the recent data “shows no sign of recession.”2 What gives?

Adding variables to the model built by our Multi-Asset research team puts us closer to the Goldman view—indeed, it paints an even more favorable picture. If we add stock index returns from the last year and the level of unemployment to our model, the statistical recession probability drops from 92% to 11%. (See an important caveat on these probabilities further down.)

My view: I’m relatively optimistic about the U.S. economy and trust this broader model. Equity valuations and spread levels agree. Hence, opportunities to significantly overweight risk assets are limited. The Asset Allocation Committee’s analysis supports a fully invested (neutral) or slightly risk-on position. Investors could also consider averaging in equities throughout this historically weak season and potential election‑related volatility.

The model

How do we arrive at the 92% and 11% probabilities?

We start with three indicators:

  • The Institute for Supply Management’s Manufacturing PMI
  • The difference between the 10- and 2-year U.S. Treasury yields (the 10–2 yield curve)
  • The change in U.S. unemployment over the last year

Our model accounts for volatilities and correlations across the indicators. This is important. It’s not just about the level of each variable, it’s also about the “configuration” or interaction among them.3

The table below shows current values for each variable compared with historical averages one month before and during recessions.

Historical Recession Indicators

Historical Recession Indicators

January 1970–August 2024
Source: Macrobond. All data as of August 2024. Recession and pre-recession averages are based on National Bureau of Economic Research dated recessions from 1/31/1970 to 8/31/2024 and are winsorized* at 2.5% and 97.5%. All series start in 1970, except for the 10–2 curve, which starts on 6/30/1976.
* Winsorized refers to a method of averaging that minimizes the impact of outlying numbers. It is a statistical technique that limits the impact of outliers in a dataset by replacing extreme values with less extreme values.

According to our model, using these three indicators generates a statistical probability of recession of 92%. Historically, when moving into recessions, Manufacturing PMIs have fallen, the yield curve has de-inverted, and unemployment has risen—all similar to the current environment. It’s a toxic brew of indicators in precisely the right proportions for a recession.  

Next, we add the following two variables:

  • S&P 500 Index returns (last 12 months)
  • U.S. unemployment level

Historical Recession Indicators (Expanded)

Historical Recession Indicators (Expanded)

January 1970–August 2024
Source: Macrobond for all data except S&P 500 (Haver). All data as of August 2024. Recession and pre-recession averages are based on National Bureau of Economic Research dated recessions from 1/31/1970 to 8/31/2024 and are winsorized at 2.5% and 97.5%. All series start in 1970, except for the 10–2 curve, which starts on 6/30/1976.

Repeating the same statistical calculations, the probability falls to 11%. Based on historical evidence, strong stock market returns and low unemployment rates are unlikely to signal a recession. Of course, using stock returns can lead to a circular reference when making investment decisions, but stocks are considered a leading indicator of recessions.

A caveat: We tested several variations of these models, and the 92% to 11% disparity between any two was the highest—and best amplifies my point that the data that you choose to use have a major impact on recession probabilities. Across iterations, however, we observed the same general tendency of model probabilities to drop when adding a broader range of indicators that account for market variables (stock returns, credit spreads) and employment data levels (unemployment, claims, job openings, etc.). Adding services PMI also lowered the probability.

Conclusions

My takeaway is not that “this time is different”—saying that is worse than swearing in some investment circles. But I think that the recession narrative for the U.S. has conveniently ignored the bright green “cushions” created by the pandemic normalization, aggressive fiscal spending, and the positive liquidity impact of preemptive Fed cuts.

As for our positioning, with bright red signals to the left and bright green signals to the right, should we stay in the middle lane when it comes to stocks versus bonds? 

Perhaps we should since equities seem to be pricing in the optimistic scenario. However, our Asset Allocation Committee has started discussing at what S&P 500 level we would be prepared to add to risk assets should we encounter volatility over the next few months— which is highly likely given the upcoming election. 

Collaborators: Leo Liu, Charles Shriver, and Rob Panariello. Special thank you to Leo Liu for running the empirical analysis on short notice.

Sébastien Page Head of Global Multi-Asset and CIO

Sébastien Page is head of Global Multi-Asset and chief investment officer. He is a member of the Asset Allocation Committee, which is responsible for tactical investment decisions across asset allocation portfolios. Sébastien also is a member of the Management Committee of T. Rowe Price Group, Inc.

Sep 2024 • From the Field • Article

Cutting cycles and learning to love bonds again

History provides some clues about which asset classes are likely to outperform
By  Sébastien Page

1 https://abcnews.go.com/Business/recession-fears-loom-economy-time/story?id=112588104

2 https://www.cnbc.com/2024/08/19/goldman-sachs-cuts-odds-of-us-recession-to-20percent-on-fresh-data.html

3 My team and I use the so-called multivariate Mahalanobis distance measure. For an overview of some of the main theoretical foundations behind our model, see: https://globalmarkets.statestreet.com/research/service/public/v1/article/insights/pdf/v2/5b4b47fa-8256-4e4a-8991-afe13469268b/joim_a_new_index_of_the_business_cycle.pdf

T. Rowe Price cautions that economic estimates and forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual outcomes could differ materially from those anticipated in estimates and forward-looking statements, and future results could differ materially from historical performance. The information presented herein is shown for illustrative, informational purposes only. Any historical data used as a basis for analysis are based on information gathered by T. Rowe Price and from third-party sources and have not been verified. Forecasts are based on subjective estimates about market environments that may never occur. Any forward-looking statements speak only as of the date they are made. T. Rowe Price assumes no duty to, and does not undertake to, update forward-looking statements.

Important Information

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

Australia—Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 28, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000, Australia. For Wholesale Clients only.

Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.

EEA—Unless indicated otherwise this material is issued and approved by T. Rowe Price (Luxembourg) Management S.à r.l. 35 Boulevard du Prince Henri L-1724 Luxembourg which is authorised and regulated by the Luxembourg Commission de Surveillance du Secteur Financier. For Professional Clients only.

New Zealand—Issued by T. Rowe Price Australia Limited (ABN: 13 620 668 895 and AFSL: 503741), Level 28, Governor Phillip Tower, 1 Farrer Place, Sydney NSW 2000, Australia. No Interests are offered to the public. Accordingly, the Interests may not, directly or indirectly, be offered, sold or delivered in New Zealand, nor may any offering document or advertisement in relation to any offer of the Interests be distributed in New Zealand, other than in circumstances where there is no contravention of the Financial Markets Conduct Act 2013.

Switzerland—Issued in Switzerland by T. Rowe Price (Switzerland) GmbH, Talstrasse 65, 6th Floor, 8001 Zurich, Switzerland. For Qualified Investors only.

UK—This material is issued and approved by T. Rowe Price International Ltd, Warwick Court, 5 Paternoster Square, London EC4M 7DX which is authorised and regulated by the UK Financial Conduct Authority. For Professional Clients only.

USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.

© 2024 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.

202410-3925565

Open

Audience for the document: Share Class: Language of the document:
Open Cancel

Download

Share Class: Language of the document:
Download Cancel
Sign in to manage subscriptions for products, insights and email updates.
Continue with sign in?
To complete sign in and be redirected to your registered country, please select continue. Select cancel to remain on the current site.
Continue Cancel
Once registered, you'll be able to start subscribing.

Change Details

If you need to change your email address please contact us.
Subscriptions
OK
You are ready to start subscribing.
Get started by going to our products or insights section to follow what you're interested in.

Products Insights

GIPS® Information

T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. T. Rowe Price has been independently verified for the 27-year period ended June 30, 2023, by KPMG LLP. The verification report is available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report.

TRP is a U.S. investment management firm with various investment advisers registered with the U.S. Securities and Exchange Commission, the U.K. Financial Conduct Authority, and other regulatory bodies in various countries and holds itself out as such to potential clients for GIPS purposes. TRP further defines itself under GIPS as a discretionary investment manager providing services primarily to institutional clients with regard to various mandates, which include U.S, international, and global strategies but excluding the services of the Private Asset Management group.

A complete list and description of all of the Firm's composites and/or a presentation that adheres to the GIPS® standards are available upon request. Additional information regarding the firm's policies and procedures for calculating and reporting performance results is available upon request

Other Literature

You have successfully subscribed.

Notify me by email when
regular data and commentary is available
exceptional commentary is available
new articles become available

Thank you for your continued interest