Tag: recession
Asset Allocation Bi-Weekly – No Country for Recessions (August 4, 2025)
by Bill O’Grady | PDF
Recessions in the United States have become less frequent over time. To illustrate this, the chart below shows data from the National Bureau of Economic Research, the official arbiter of recessions in the US, which has been establishing business cycles since January 1854. In the chart, we show the total months spent in recession over a rolling 10-year period. Clearly, we have seen the incidence of recession decline over time. From 1864 until 1940, recessions occurred, on average, 54 months out of 120 months, or 45% of the time. From 1941 to 1991, the average declined to 21 months, or 18% of the time. Since 1991, the average fell to 10 months, or 8% of the time.
Why has the incidence of recessions declined? There are three primary reasons. First, as the economy evolved into being dominated by services instead of manufacturing, there were less inventory misallocations causing slumps, especially after 1980. As shown in the next chart, inventories relative to gross domestic product (GDP) have clearly fallen. Therefore, the likelihood of excess inventories or other issues arising from misallocation of inventory also fell.
Second, until the 1930s, recessions were thought to be natural occurrences. Often, the burden of policies that allowed recessions tended to fall on debtors and the lower classes, who had limited political influence. After WWI, this idea became contested and was one of the reasons for the unraveling of the gold standard. Because the gold standard created inelastic conditions for liquidity, central banks were restricted from easing credit conditions during downturns, leading to deflation. After WWII, monetary and fiscal policy became countercyclical; in other words, policies were designed to either prevent or mitigate recessions. By the mid-1990s, monetary policy transparency became the norm, further reducing the amount of policy shocks.
The third factor behind less-frequent recessions is the expansion of globalization that started in 1978 with deregulation and accelerated after the end of the Cold War. The rise of globalization increased the available supply, which led to lower inflation and a decline in interest rates. This period, dubbed “the great moderation,” made it easier to extend the business cycle.
This history raises two questions. First, will this period of infrequent recessions continue? And second, what are the ramifications if it does? Addressing them in order, it’s likely that infrequent recessions will continue because two of the three conditions described above should remain in place. We expect that services will continue to dominate the economy, while modern inventory management will maintain stability. At the same time, countercyclical policy isn’t likely to change. If anything, policy accommodation appears to be expanding (raising inflation concerns). In our view, only the third condition for less-frequent recessions will be less supportive. As the US attempts to rebalance the global trading environment, imports will become less plentiful, and the potential for supply shocks will rise. Of course, as domestic production responds, the potential for foreign-driven supply shocks (as observed during the pandemic) will also be less of an issue. But overall, the trend toward fewer downturns looks to be in place.
What does this mean for equity markets? Less frequent recessions, at least in the postwar period, correlate with higher price/earnings multiples. We show this in the chart below, which overlays the rolling decades of recessions with the Shiller cyclically adjusted P/E ratio. From 1870 to 1950, the correlation was low and positive. However, since 1950, the correlation has increased significantly and turned negative. In other words, the declining occurrence of recessions is now associated with higher stock valuations.
Finally, the chart below shows S&P 500 earnings on a four-quarter rolling basis compared to a regression of earnings to nominal GDP. Recessions are indicated by the vertical grey bands. The chart shows that, in the postwar era, recessions tend to depress earnings. Thus, if recessions remain less frequent, it makes sense that the earnings multiple would be higher. Investors generally can worry less about economic downturns, giving them greater confidence to bid up stock values relative to earnings.
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Business Cycle Report (July 31, 2025)
by Thomas Wash | PDF
The business cycle has a major impact on financial markets; recessions usually accompany bear markets in equities. The intention of this report is to keep our readers apprised of the potential for recession, updated on a monthly basis. Although it isn’t the final word on our views about recession, it is part of our process in signaling the potential for a downturn.
The US economy sustained its expansion in June, and our proprietary Confluence Diffusion Index stayed out of contraction territory for the fifth straight month. Most indicators showed improvement or only modest changes from the prior month. Financial markets reflected continued optimism from trade progress, lifting equity sentiment, while bond markets signaled lingering uncertainty over inflation and monetary policy. The real economy is showing resilience, with production levels improving (though still well below their peak) and both business and consumer sentiment on the rise. The labor market also looks stable as firms remain reluctant to cut jobs.
Financial Markets
Equity markets are adjusting to tariff-related headlines as confidence grows that the worst of the disruptions has passed. This optimism has driven a sustained rally, with tech stocks leading the gains. US government bonds have remained rangebound as a decline in the 10-year Treasury yield has pushed the financial spread (measured by the 10-year yield minus the effective fed funds rate) into contraction territory. However, this compression likely reflects shifting expectations around Fed policy rather than underlying economic stress as markets continue to assess the timing and magnitude of potential rate cuts this year.
Goods Production & Sentiment
The goods production and sentiment segments remain the weakest component of the business cycle report. In June, three of the four key diffusion indicators remained in contraction. While consumer sentiment showed an improved household inflation outlook, concerns have shifted toward labor market conditions. Business sentiment also edged higher, with supplier deliveries continuing to signal expansion. On a positive note, housing construction activity picked up modestly, led by multi-family projects. Meanwhile, a proxy for investment spending showed marginal improvement but stayed in contractionary territory.
Labor Market
The latest labor market data underscored the economy’s continued durability, with the unemployment rate unexpectedly dropping to 4.1% as more people secured jobs, though a deeper dive into the payroll numbers reveals a more nuanced picture. Nearly half of all new positions were created in state and local governments, highlighting the public sector’s outsized role in driving recent job growth. The steady decline in jobless claims suggests private employers are also retaining workers, signaling broader labor market strength.
Outlook & Risks
The economy is proving to be remarkably resilient, even with new tariffs in play. As trade deals are concluded, businesses and households should gain a clearer roadmap for navigating this evolving landscape. The new tax bill is a welcome shot of relief and is set to reduce recession risk. We’ll get an even better read on its full positive impact over time. Our focus stays squarely on earnings. As long as firms show flexibility and creativity in adjusting, we anticipate continued stability. But if companies shrink their margins, we could still see some economic volatility.
The Confluence Diffusion Index for July, which encompasses data for June, remained slightly above the recovery indicator. However, the report revealed that four of the 11 benchmarks remained in contraction territory from last month, and one additional indicator has now crossed into contraction for the month of June. Using June data, the diffusion index was unchanged at -0.0303, above the recovery signal of -0.1000.
- Stocks sustained the previous month’s momentum while bonds remain in holding.
- Sentiment and production showed signs of improvement.
- The labor market has softened but remains tight.
The chart above shows the Confluence Diffusion Index. It uses a three-month moving average of 11 leading indicators to track the state of the business cycle. The red line signals when the business cycle is headed toward a contraction, while the blue line signals when the business cycle is in recovery. The diffusion index currently provides about six months of lead time for a contraction and five months of lead time for recovery. Continue reading for an in-depth understanding of how the indicators are performing. At the end of the report, the Glossary of Charts describes each chart and its measures. In addition, a chart title listed in red indicates that the index is signaling recession.
Business Cycle Report (June 26, 2025)
by Thomas Wash | PDF
The business cycle has a major impact on financial markets; recessions usually accompany bear markets in equities. The intention of this report is to keep our readers apprised of the potential for recession, updated on a monthly basis. Although it isn’t the final word on our views about recession, it is part of our process in signaling the potential for a downturn.
The US economy extended its expansion in May, with the composite economic index remaining above contraction territory for the fourth consecutive month. While financial conditions broadly improved, the goods-producing sector sent mixed signals and the labor market showed tentative signs of softening. Against a backdrop of lingering tariff uncertainty, we are closely monitoring labor market conditions and goods production for early indicators of economic stress.
Financial Markets
Investors largely shrugged off trade tensions amid progress in negotiations with China, the UK, and India. Optimism that tariffs may not escalate further buoyed risk sentiment, fueling rallies in major tech stocks. Meanwhile, rising sovereign debt concerns in developed markets pushed long-term Treasury yields higher, steepening the yield curve. As a result, the financial spread moved into positive territory for the first time in three months — a potential signal of improving growth and inflation expectations.
Goods Production & Sentiment
The goods-producing sector was the economy’s softest segment in May, with three of the four key diffusion indicators in contraction. Consumer sentiment remained subdued due to persistent inflation expectations and tariff uncertainty. Housing construction slowed under pressure from elevated interest rates and rising material costs. While a proxy for investment spending improved slightly, it remained in contraction territory. Business surveys indicated lingering supply chain pressures, with slow delivery times suggesting a sustained demand for factory goods.
Labor Market
The labor market continued to moderate but remains robust by historical standards. The unemployment rate held steady at 4.2%, suggesting that while labor conditions have eased from their peak, they remain tight. However, initial jobless claims rose noticeably and payroll growth slowed in May, both early signs that employers may be scaling back hiring. For now, the data does not yet warrant policy intervention, but further softening could shift the Fed’s outlook.
Outlook & Risks
The economy continues to demonstrate resilience, supported by steady consumer and business spending. However, much of this strength may reflect drawdowns of pre-tariff inventory stockpiles. While we do not anticipate a near-term recession, the critical question is whether firms can absorb higher tariff costs through compressed margins or would they be able to pass them on to consumers without stifling demand. The coming months will test the economy’s ability to adapt to these persistent headwinds, but we still think this remains a good time to increase risk exposure.
The Confluence Diffusion Index for June, which encompasses data for May, remained slightly above the recovery indicator. However, the report showed that four out of 11 benchmarks are in contraction territory. Using May data, the diffusion index improved to -0.0303, above the recovery signal of -0.1000.
- Stocks gained momentum as progress in trade negotiations boosted investor sentiment.
- Rising input costs continue to weigh on the manufacturing sector.
- A noticeable uptick in jobless claims points to a potential softening in the labor market.
The chart above shows the Confluence Diffusion Index. It uses a three-month moving average of 11 leading indicators to track the state of the business cycle. The red line signals when the business cycle is headed toward a contraction, while the blue line signals when the business cycle is in recovery. The diffusion index currently provides about six months of lead time for a contraction and five months of lead time for recovery. Continue reading for an in-depth understanding of how the indicators are performing. At the end of the report, the Glossary of Charts describes each chart and its measures. In addition, a chart title listed in red indicates that the index is signaling recession.
Asset Allocation Bi-Weekly – #142 “The Economy That Won’t Die” (Posted 6/16/25)
Asset Allocation Bi-Weekly – The Economy That Won’t Die (June 16, 2025)
by Thomas Wash | PDF
The old Wall Street quip about economists having “predicted nine of the last five recessions” has never felt more painfully relevant. Since the pandemic era began, economists have sounded the recession alarm no fewer than three times: first when gross domestic product (GDP) shrank in early 2022, again during the Silicon Valley Bank crisis of 2023, and most recently when the Sahm Rule was triggered during the summer of 2024. Yet America’s economic engine keeps chugging along, leaving analysts scrambling to explain why the doom forecasts keep missing their mark.
The stock market’s reaction to President Trump’s tariff announcement followed this now-familiar pattern of panic and resilience. Initial headlines sparked a sell-off that briefly dragged the S&P 500 stock price index below 5,000 for the first time in months. But within weeks, the index came roaring back, erasing its year-to-date losses and flirting with bull market territory. This whipsaw action revealed an important truth: Investors are increasingly betting that the economy can absorb policy shocks that would have crippled previous expansions.
This underlying economic resilience, even in the face of apparent warning flags, highlights the importance of looking beyond superficial data. The solution may lie in what analysts call “core GDP,” which measures the final sales to private domestic purchasers. Where the headline GDP figure mixes volatile government spending and trade data with underlying demand, this refined metric instead focuses solely on how much US households and businesses are actually buying. This distinction proved critical in understanding the first quarter’s apparent contraction, which upon closer examination revealed more about temporary distortions than fundamental weakness.
In the first quarter, a surge in imports caused by companies racing to beat the coming tariffs artificially depressed the GDP numbers, while simultaneous government spending cuts further skewed the picture. Meanwhile, the core GDP figure told a different story about the real economy. Consumer spending slowed and rotated from discretionary goods to consumer staples and services, but it didn’t contract. Most tellingly, business investment accelerated, particularly in technology sectors because of what appears to be an influx of AI-related capital expenditures.
This wave of AI investment has helped blunt the impact of tariff uncertainty in early 2025. Despite the positive momentum, a caveat remains. The economy’s and market’s reliance on technology investment seen in the first quarter may not be sustainable if trade restrictions lead to critical shortages. AI development, in particular, is vulnerable to the availability of essential mineral resources, such as rare earths, which could limit its expansion. Therefore, we believe the economy and market can continue to defy skeptics, provided trade relations are meticulously managed.
Looking ahead, we suspect that as long as the Trump administration continues to facilitate the expansion of AI firms, it will remain a positive driver of growth. For the broader economy, any indications that a trade war will not result in painful outcomes — such as elevated inflation and unemployment — should encourage increased consumer and business spending. We continue to believe that stocks and other risk assets can continue to recover, with prospects especially positive for quality assets. This assessment reflects both the prevailing uncertainty with a dash of hope for improvement after the July 9 tariff deadline.
Business Cycle Report (May 29, 2025)
by Thomas Wash | PDF
The business cycle has a major impact on financial markets; recessions usually accompany bear markets in equities. The intention of this report is to keep our readers apprised of the potential for recession, updated on a monthly basis. Although it isn’t the final word on our views about recession, it is part of our process in signaling the potential for a downturn.
In April, the US economy continued to grow broadly with no immediate signs of contraction. The composite economic index remained just above the recession threshold and showed minimal change from the previous month’s reading. While employment indicators continued to demonstrate resilience, other sectors presented a more nuanced picture. Financial markets and real economic data sent mixed signals, suggesting an economy at a crossroads between sustained growth and potential softening. This dichotomy between strong labor markets and weaker production indicators bears close monitoring in coming months.
Labor Market
The labor market showed gradual easing from its recent peaks while remaining tight by historical standards. Initial jobless claims and employer payrolls pointed to ongoing strength in the demand for labor. In contrast, the two-year change in the unemployment rate signaled potential weakness. This divergence suggests that while hiring may be cooling from its torrid post-pandemic pace, underlying demand for workers remains robust. The continued labor market tightness provides an important buffer against broader economic weakness, supporting consumer spending and overall growth.
Financial Markets
Financial markets delivered conflicting messages about economic prospects. Equity markets rallied on optimism that potential trade restrictions might be less severe than initially anticipated, reflecting confidence in corporate earnings. However, bond markets told a more cautious story, with Treasury yields ending the month slightly lower as investors priced in greater economic uncertainty. This disconnect between equity and fixed income markets typically signals investor debate about future growth trajectories, with bond markets often proving more prescient about economic turning points.
Goods Production and Sentiment
The goods-producing sector emerged as the economy’s weakest link in April, with three of four key diffusion indicators in contraction territory. Consumer sentiment remained depressed, potentially foreshadowing softer spending ahead. Business investment showed particular weakness, evidenced by sluggish housing starts and declining capital expenditures. These trends suggest corporate leaders are growing more cautious about future demand. However, supplier delivery times — often an early indicator of economic activity — remained elevated, pointing to persistent underlying demand that could support continued expansion.
Outlook and Risks
While recession risks persist, current data suggests the economy will likely avoid contraction in the near term. The primary uncertainties center on potential trade policy impacts and whether labor market strength can offset softness elsewhere. There are signs of growing margin pressures that could eventually affect hiring and investment decisions. Our baseline projection anticipates continued modest growth through the third quarter, though the economy appears increasingly vulnerable to external shocks. Investors should remain vigilant for signs of broader economic deterioration, while increasing risk exposure may be warranted as the economic outlook becomes clearer.
The Confluence Diffusion Index for May, which encompasses data for April, remained slightly above the recovery indicator. However, the report showed that five out of 11 benchmarks are in contraction territory. Using April data, the diffusion index was unchanged at -0.0909 and above the recovery signal of -0.1000.
- Equity prices bounced back following trade progress.
- Manufacturing data offered mixed signals.
- Hiring picked up in a sign that labor conditions remain tight.
The chart above shows the Confluence Diffusion Index. It uses a three-month moving average of 11 leading indicators to track the state of the business cycle. The red line signals when the business cycle is headed toward a contraction, while the blue line signals when the business cycle is in recovery. The diffusion index currently provides about six months of lead time for a contraction and five months of lead time for recovery. Continue reading for an in-depth understanding of how the indicators are performing. At the end of the report, the Glossary of Charts describes each chart and its measures. In addition, a chart title listed in red indicates that the index is signaling recession.
Business Cycle Report (May 1, 2025)
by Thomas Wash | PDF
The business cycle has a major impact on financial markets; recessions usually accompany bear markets in equities. The intention of this report is to keep our readers apprised of the potential for recession, updated on a monthly basis. Although it isn’t the final word on our views about recession, it is part of our process in signaling the potential for a downturn.
The Confluence Diffusion Index for April, which encompasses data through March, remained slightly above the recovery indicator. However, the report showed that five out of 11 benchmarks are in contraction territory. Using March data, the diffusion index was unchanged at -0.0909 and above the recovery signal of -0.1000.
- Equity prices have seen a sharp decline in momentum.
- Construction activity shows marked deceleration.
- Labor market conditions are easing slightly but remain historically tight.
The chart above shows the Confluence Diffusion Index. It uses a three-month moving average of 11 leading indicators to track the state of the business cycle. The red line signals when the business cycle is headed toward a contraction, while the blue line signals when the business cycle is in recovery. The diffusion index currently provides about six months of lead time for a contraction and five months of lead time for recovery. Continue reading for an in-depth understanding of how the indicators are performing. At the end of the report, the Glossary of Charts describes each chart and its measures. In addition, a chart title listed in red indicates that the index is signaling recession.