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Rockin’ around the recession odds
Whether the U.S. economy enters a recession in the next few
months remains an important, if not crucial, anchor for any
investment strategy. Like many others, we started 2023 with
the base-case scenario of a recession in Canada and the
United States by year-end. Even though our projections were
not too far off for Canada, we were pleasantly surprised by
the resilience of the U.S. economy.
A few reasons underlie the recent “American
exceptionalism”: the country’s tight labour market,
accumulated excess household savings and impressive fiscal
deficits. All are generally cited as reasons for optimism that a
recession may be avoided altogether.
As 2024 approaches, we’re focusing even more on identifying
signs of economic weakness in the U.S. economy. Given the
number of moving parts and the potentially conflicting macro
signals, it is crucial that we continually reassess and weight
the incoming economic indicators, as well as be prepared to
adapt our investment strategies to evolving conditions.
The Sahm rule, the current flavour of the month, was
developed by U.S. economist Claudia Sahm as a simple yet
effective tool to guide fiscal policy in real time by trying to
predict imminent recessions through unemployment rate
trends. The rule, based on historical data, suggests that when
the 3-month moving average of the unemployment rate rises
by at least 0.50 percentage points above its lowest point of
the previous 12 months, there is a high probability that a
recession is beginning or impending. Applied to data going
back to the 1970s, the Sahm rule has accurately identified
U.S. recessions with only one false positive, making it a
valuable and accessible tool for policymakers, analysts and
others interested in the health of the economy. Its
effectiveness is further demonstrated by its successful prediction of the 2007 Great Recession and the 2001
Even though this rule has a strong track record, the
unemployment rate, or any of its transformations, does not
fully reflect labour-market tightness; it only accounts for
individuals actively seeking employment. This metric
overlooks various nuances, such as underemployment, the
labour-force participation rate and the number of
discouraged workers. Consequently, a low unemployment rate might be misleading, because it may not accurately
capture the true tightness of the labour market or the
challenges faced by potential workers and employers.
The Beveridge curve, in contrast, is useful for understanding
labour-market dynamics and identifying mismatches within
the job market. For instance, an outward shift of the curve
implies a decrease in the efficiency of job matching, possibly
because of structural changes or skill mismatches whereby
job seekers don’t possess the required skills for the available
positions. The Beveridge curve currently shows that the ratio
of job openings to labour force is in a downtrend, but that the
unemployment rate is stable. In other words, the labour
market is loosening even if we don’t see a material change in
the unemployment figures.
According to the most recent long-term population
projections from the U.S. Census Bureau, it appears that the
U.S. labour market could remain persistently tight for the
foreseeable future. With the growth of the working-age
population in the current decade being the lowest since the
Civil War, businesses and policymakers are likely to face
considerable challenges in addressing labour shortages. This
reduced labour-force growth is attributed primarily to lowerthan-expected immigration rates, which, in turn, affect the
overall availability of workers for various industries.
The tight labour market raises several macroeconomic
concerns, for it can lead to wage pressures and economic
imbalances if not addressed effectively. It also has
implications for economic growth and the ability of
businesses to expand their operations. Furthermore, the
reduced labour-force participation may affect consumption
patterns, which play a critical role in driving economic
growth. Inflationary pressures may arise in some sectors if the demand for goods and services outpaces the labour
supply required to produce them.
Excess savings have been one of the most significant
economic stories during and in the aftermath of the
pandemic, contributing to the resilience of the U.S. economy.
Lockdowns led households to save more than they might
have otherwise, and recent data from the Bureau of
Economic Analysis suggest that the U.S. excess savings rate
may be higher than previously thought.
Higher-than-expected excess savings have acted as a financial
cushion, enabling consumers to maintain their spending
despite concerns over inflation and interest rates. As
consumers continue to tap into their excess savings, demand
for goods and services continues to be sustained, thereby
contributing to the overall economic recovery.
Even so, it is essential to monitor the exact amount of savings
and how much remains, as different estimates can affect
inflation, growth and the U.S. economy’s resilience. The most
recent GDP revisions gave a $357-billion boost to excess
household savings. As these excess savings are depleted, we
should expect a reduction in consumer spending, possibly
with ripple effects on various economic sectors and policy
The rise in the U.S. deficit has played a significant role in
propping up the economy and contributing to its resilience
during the pandemic. Officials resorted to aggressive fiscal
stimulus to prevent the health crisis from turning into an
economic one. The U.S. implemented its measures at a larger
scale than many other regions, resulting in a primary
government deficit of 9.4% of GDP in 2021, which came down
to 1.3% in 2022 before jumping again to 5.5% in 2023.
This substantial fiscal response has supported the U.S.
economy, particularly by driving a recovery in consumer
spending. As a result, generous government support has been
a prime reason for the robust economic growth that the
country has experienced during these challenging times.
What does our recession model say?
Our in-house recession model attempts to identify economic
turning points 3 months before they occur by taking into
account a comprehensive set of variables that includes, but is
not limited to, unemployment, economic indicators and
various characteristics of the yield curve. We use a
multivariate logistic regression to forecast the probability of a
recession, as defined by the National Bureau of Economic
Our approach thus quantifies as a probability measure of the
risk of a recession according to the current economic climate.
It is purely forward-looking because it doesn’t rely on a set of
As can be seen below, our model currently forecasts the
probability of a recession over the next 3 months at 66%, one
of its highest historical readings.
No matter how good any model may be, it is still a stylized
version of reality with obvious limitations. We think that, over
the next few months, in addition to monitoring our model,
we should be paying attention to four key developments that
will be crucial in determining whether the United States
economy enters a recession:
- What is the current state of the U.S. job market?
Does the unemployment rate continue to rise? Is the
ratio of job openings to job seekers tightening?
- How are excess savings faring? Can the U.S.
consumer continue to spend and support the
- How far is the U.S. government willing to go to
continue supporting the economy, especially given the coming electoral cycle? How will the recurrent
debt-ceiling negotiations affect its ability to do so?
- How does monetary policy continue to propagate
through the economy? Do we continue to see a
tightening in lending standards? Are delinquencies
turning into outright defaults?
There isn’t much love for global equities emanating from our
macroeconomic indicators, that’s for sure. Monetary policy
continues to make its way toward the heart of the economy,
the labour market, as shown by the rise of the unemployment
rate since the first quarter of 2023. The long and variable lags
have historically played tricks on investor sentiment, with the
“this time is different” narrative being a regular feature of the
end of most hiking cycles. Given the speed of tightening by
the Fed and the Bank of Canada alike in the second half of
2022, it’s only natural to expect the first half of 2024 will see
a further sharp deterioration of labour markets.
The global manufacturing sector is already in a recession and,
despite signs of a recent bottoming, could remain under
pressure because the drawdown in the inventory cycle
(another regular late-cycle feature) is yet to be completed.
The state of the global manufacturing cycle and the credit
impulse from China have demonstrated their potency as
leading indicators of the performance of the global stocks/bonds ratio. At the end of November 2023, both
indicators suggest that bonds should be favoured over
equities in the coming months.
In terms of momentum, our framework paints a diverging
Starting with the U.S. indexes, we see that the short-term
trends have improved to neutral in the past month, while the
long-term trends have deteriorated somewhat. The mediumterm trend on both NASDAQ and the S&P 500 are in positive
territory, painting an overall better picture than last month’s.
Outside the United States, we note that momentum signals
are generally negative on every window, with the Nikkei
being the lone exception. Over all, the picture remains
somewhat negative, suggesting that momentum is not on the
side of the global ex-U.S. stock market.
As for valuation, November’s strong market performance
pushed most markets into pricier territory.
While U.S. large-cap equities were still posting the loftiest
valuations, we note that emerging markets also saw a rapid
rise in their valuation metrics in November, with the median
jumping 27 percentiles. Given the weight of the United States
in MSCI’s World Index and its All Country World Index, the
valuation picture has become unfavourable to global equity
indexes, but some pockets of value can be identified.
Looking at the table below, we see that the Russell 2000,
S&P/TSX, MSCI Japan and MSCI EAFE all continued to offer
relatively attractive valuations, with medians below 50%.
Turning to sentiment, we note that investor perception has
been volatile since 2022, and the recent readings from some
of our favoured indicators are again contradictory. The AAII
sentiment survey shows a recent fall in the reported average
share of stocks as a percentage of total holdings by retail
investors, but the well-followed JP Morgan Global Equity
Sentiment Indicator and the bull-bear spread from AAII
suggest more love for equities.
Finally, the VIX index suggests that nervousness about a
rebound in market volatility has all but disappeared, with the
index touching a post-pandemic low below 13.0 toward
month-end. All in all, this suggests a more balanced picture
on sentiment, with enthusiasm making a comeback of late.
Wrapping up equities, we note that our macro signals and
momentum do not tell a compelling story for risk taking, but
valuations and sentiment combine to advocate for a less
defensive positioning outside the large U.S. indexes.
North American long rates took a dive in November, leading
us to tactically change some of our views.
Our macro framework is still sending convincing signals to
overweight sovereign bonds and duration, but the speed and amplitude of the recent move lower on rates led us to trim
our exposure, for the time being.
The recent slowdown in total inflation brought both the
breakeven and the term premium down sharply in November,
as the soft-landing and Fed-to-start-cutting-by-mid-2024
theses quickly gained traction. Because our leading indicators
suggest that inflation might be more persistent than the
market expects, causing the Fed to move more slowly than
what is currently priced in, we maintained a smaller
overweight in long-duration sovereign bonds, with an eye to
adding more when rates retrace some of their recent move.
Turning to momentum, the most recent trend took a sharp
turn higher in November, as incoming data comforted
investors that rate cuts were around the corner. The
performance of the 10-year bond indexes was strong enough
during the month to prompt us to tactically close part of our
overweight position, from double positive to single positive.
The road ahead could continue to be bumpy, and a tactical
approach should benefit our overall stance on fixed income.
From a valuation perspective, sovereign bonds continued to
offer historically attractive yields.
Looking at corporate bonds, we see that IG and HY spreads
tightened some more in November. IG spreads touched a
year-to-date low late in the month, reaching a level that
makes us confident that the time is right to move from
overweight toward neutral in this asset class. As this view was
expressed as a relative one, with HY corporates on the other
side of the trade, the result is that we moved one notch
closer to neutral on HY, from double negative to single
Over all, we still think corporate spreads are relatively tight,
given our expectation of more economic pain in 2024, and
our net view on corporates, as of late November, was to
remain slightly underweight HY bonds.
Finally, looking at investor sentiment, we note that the MOVE
Index (representing the bond market’s implied volatility) continues to stick out and to suggest lingering, although
slowly declining, nervousness in the market. This index
contrasts sharply with the VIX, which is signalling that equity
investors expect a smooth road ahead.
Even though this nervousness is not surprising, given how
violent the recent repricing of the bond market has been, it
does continue to suggest that a contrarian long position on
sovereign bonds makes sense. The JP Morgan Client Survey
Indicator also sent a positive signal that institutional investors
remain net long.
Last, the put/call ratio on 10-year U.S. Treasuries moved
below 1 in the past month but seemed to have turned the
corner, indicating much less appetite for protection and more
positive views on the asset.
Over all, momentum has been strong enough for short-term
shifts to some of our positions. We think the convincing
signals from our macro, valuation, and sentiment analysis
combine to support an overweight position in high-duration
sovereign bonds, paired with an underweight position in
lower-quality HY bonds.
Commodities and Foreign Exchange
The markets seem to have shifted their focus away from the
geopolitical tensions in the Middle East, with Brent falling to
about $80 a barrel in November.
Recent talk that OPEC+ may extend its cuts seems to have put
a floor under the oil price, although the recent resurgence in
U.S. production is a risk factor to our positive view. Again, we
note that base metals could be favoured in a scenario where
energy prices are much less of a drag on global growth.
Even though our conviction has faded somewhat, we still
think commodities could outperform U.S. equities in the
coming months and therefore maintained an overweight
position in oi
Our momentum analysis framework suggests that oil’s trend
may have shifted lower in November, while those of gold and
copper recently improved.
Since last month’s comments on gold, we haven’t seen a
convincing signal that would prompt us to move away from
our neutral view on the yellow metal.
Gold had a volatile month in November, going from $2,000 to
$1,950 and back, without a clear macro story to support the
swings. We note that gold’s outperformance versus the broad
CRB Index continued over the past month in a sign of
We are keeping a keen eye on real rates and the U.S. dollar,
with both having moved lower recently, and will stay on the
sidelines until a clear entry point manifests itself for gold.
Looking at currencies, we see that the strength of the U.S.
dollar has been significant since the summer, but that a
reversal seems to be under way. The greenback typically gets
stronger when the global economy deteriorates and turns
around when the global macro picture finds its footing. While
we remain skeptical that the bottom is in for the global
economic cycle, given the long and variable lags of monetary
policy, we tactically shifted our view to neutral in the short
term and took some profits on this trade.
As for the Canadian dollar, momentum shifted swiftly in
November, as with the euro for the fast and medium
components. Given this change of trend, we moved from an
overweight position in the U.S. dollar back to a neutral