Charting the Odds of a U.S. Recession: Will Investors Be Ready?

Charting the Odds of a U.S. Recession: Will Investors Be Ready?

The U.S. economic expansion is now in its ninth year, and the economy will likely cross the divide into recession sometime in the coming three to five years. As the chart shows, since 1946 there has been just one 10-year period and only four five-year periods in which the U.S. did not experience a recession, and the current expansion is already the third-longest in postwar history.

While we don’t expect a recession in the next six to 12 months, recessions are notoriously difficult to forecast, so it’s worth speculating on the events and environments that could trigger the next one.

We see one scenario where the economy bumps along until a major external shock hits: think another Korean War, a messy euro breakup or an oil supply shock. The recession – caused by the resulting plunge in asset prices and falling business and consumer confidence – could be relatively shallow but last longer than usual due to insufficient fiscal and monetary responses.

Or consider a second scenario, where an internal buildup of imbalances and overheating goods, labor or asset markets rattle the economy and compel the Fed to hike rates. The script for this endogenous recession would likely be sharper and deeper, but having built up enough “dry powder” in the form of higher rates, the Fed could cut rates to promote a V-shaped recovery.

The real-deal next recession could, of course, turn out differently – and given the uncertainty, how should investors prepare? In our recent Secular Outlook, we discuss a focus on valuations (lots of good news is priced in to markets) and capital preservation, seeking relative value in rates and credit, and looking to a global opportunity set, including emerging markets. Nontraditional options like managed futures have also shown strong historical performance during bear markets and may mitigate risk in broader portfolios.

Bottom line? Enjoy this expansion while it lasts. But don’t wait until the next recession hits to start preparing.

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