Economic conundrum
Whether the global economy falls into recession this year remains too close to call. Recent data continue to suggest the economic expansion is intact. Job creation, wage growth, and consumer spending in major economies remain solidly positive. The U.S. economy has added roughly 1.1 million jobs since the beginning of 2023, boosting total employment to a record just north of 155 million jobs. Alongside this economic resilience, inflation has steadily trended downwards after hitting multi-decade highs in many major economies last year.
Although the broad message is that the economy is not at risk of an imminent downturn, we believe the balance of the evidence still points to a subdued economic outlook that could entail a possible recession on a 12-month horizon. The bulk of the indicators in RBC Global Asset Management’s U.S. economic cycle scorecard have moved into a “late cycle” diagnosis, and our U.S. recession risk scorecard continues to signal caution ahead.
Meanwhile, the global growth rebound at the start of the year, though reassuring, appears short term. Our take is that some of the recent conflicting macro signals can be reconciled by the typical “leads and lags” between changes in interest rates and changes in economic conditions, whereby the impact of increasingly restrictive monetary policy manifests across different parts of the economy with a variable time delay.
Economic surprises have turned lower
Line chart showing economic surprise indicators for the global, U.S., and eurozone economies for January 2022 through May 19, 2023 period. These indicators provide insight into whether economic data have been coming in better or worse than consensus estimates. The indicators have turned lower in recent months after a strong start to the year, indicating economic data have been surprising to the downside compared to market expectations.
Source - RBC Wealth Management, Bloomberg; data through 5/19/23
The current economic cycle is unlikely to prove different, in our view. This means the side effects from the rapid rate hikes by major central banks over the past 14 months will likely continue to permeate the economy beyond the most rate-sensitive sectors—such as real estate and banking—which have already come under duress. Even in the U.S. labour market, which has been a key source of strength, some hints of weakness are starting to emerge, as job openings have declined and layoffs have picked up in recent months, albeit from fairly benign levels.
No “one size fits all” recession template
All economic expansions eventually end as recessions are an ordinary part of the business cycle. But, it is important to keep in mind that recessions are relatively brief and bring about a wide spectrum of market outcomes.
Our analysis of the U.S. business cycles since 1945 shows there have been 13 recessions. This means investors should expect to experience a downturn once every six to seven years and lasting between two and 18 months, with a 10-month average. In contrast, U.S. expansions have endured 62 months on average. Growth is the regular state of the economy, and over the past eight decades the U.S. economy has spent nearly 90 percent of the time in expansion mode.
Length of U.S. economic expansions and recessions since 1945
Bar chart showing there have been 13 recessions of the U.S. business cycles since 1945. These recessions have lasted between two and 18 months, with the average spanning roughly 10 months. In contrast, U.S. expansions have endured an average of 62 months.
Source - RBC Wealth Management, National Bureau of Economic Research; data through 4/30/23
As recessions can vary greatly in length and severity, so too can the equity market responses during recessions. While the S&P 500’s average decline was 32 percent around the previous 13 recessions, magnitudes ranged from 15 to 57 percent.
S&P 500 corrections surrounding recessions
| Recession dates | Decline details | Recession-related details | ||||
|---|---|---|---|---|---|---|
| Market peak date | Days to bottom | Decline % | Recession length (months) | Did the market bottom before the recession ended? | No. of months from market bottom to end of recession | |
| May 1937 – June 1938 | 3/10/37 | 386 | -54% | 14 | Yes | 3.0 |
| Nov. 1948 – Oct. 1949 | 6/15/48 | 363 | -21% | 12 | Yes | 5.1 |
| July 1953 – May 1954 | 1/5/53 | 252 | -15% | 11 | Yes | 9.1 |
| Aug. 1957 – April 1958 | 7/15/57 | 99 | -21% | 9 | Yes | 5.0 |
| April 1960 – Feb. 1961 | 8/3/59 | 449 | -14% | 11 | Yes | 4.0 |
| Dec. 1969 – Nov. 1970 | 11/29/68 | 543 | -36% | 12 | Yes | 6.1 |
| Nov. 1973 – March 1975 | 1/11/73 | 630 | -48% | 17 | Yes | 6.1 |
| Jan. 1980 – July 1980 | 2/13/80 | 43 | -17% | 7 | Yes | 4.1 |
| July 1981 – Nov. 1982 | 11/28/80 | 622 | -27% | 17 | Yes | 4.1 |
| July 1990 – March 1991 | 7/16/90 | 87 | -20% | 9 | Yes | 6.1 |
| March 2001 – Nov. 2001 | 3/24/00 | 929* | -49% | 9 | No | N/A** |
| Dec. 2007 – June 2009 | 10/9/07 | 517 | -57% | 19 | Yes | 4.1 |
| Feb. 2020 – April 2020 | 2/19/20 | 33 | -34% | 3 | Yes | 1.0 |
| Average | 381 | -31.8% | 11.5 | — | 4.8 | |
The 1945 recession is excluded as there was no clear stock market pullback around it. * Surrounding the recession in March 2001 – November 2001, the pullback statistics are based on a March 2000 peak and October 2002 low; the market hit an initial low in November 2001, which was retested and surpassed in 2002. ** The market didn’t bottom until 10 months after the recession ended; this data is not included in the average calculated for this column.
Source - RBC Capital Markets U.S. Equity Strategy, Haver Analytics, RBC Wealth Management
Even though we think the U.S. economy could potentially slip into a recession sometime in the next few quarters, considerable ambiguity around timing and severity remains. Most importantly, the household consumption pillar of the economy remains in reasonably good shape, reinforced by ample job opportunities, steady income gains, and a decent amount of savings that can be drawn on to maintain spending.
A recent Fed study estimated U.S. households were still sitting on $500 billion in excess savings, a large pile that could continue to backstop consumer spending “at least into the fourth quarter of 2023.” Debt service burdens for households and businesses are gradually rising as borrowing costs have jumped over the past year, but they broadly remain at manageable levels. Absent unexpected shocks, these factors could help alleviate the severity of the next downturn.
Investment takeaways
Risk appetite in H1 2023 has benefited from a modest uplift in economic activity indicators and fading inflation fears, but we believe the path forward will likely be more challenging. With inflation still running well above target in many developed economies, major central banks may have to keep borrowing costs at restrictive levels for longer, suggesting the drag on the economy from sharply higher interest rates will likely continue to intensify in the coming months.
In the near term, hopes of a “soft landing” with inflation swiftly returning to central banks’ targets will continue to push and pull against lingering concerns of a deeper recession and sticky inflation that remains above target, in our opinion. As the perceived likelihood of each scenario evolves in response to incoming data, this could contribute to potentially outsized swings in financial markets.
Given our view that the U.S. economy is in a late-cycle expansion phase, and with central banks still navigating a tricky balancing act of preventing inflation from becoming entrenched while avoiding the risk of a sharp slowdown and financial stability, we believe a moderately defensive stance in portfolios remains appropriate.
Businesses have been coping with less favourable operating conditions. Better-than-expected resilience in corporate earnings has partially supported a rebound in equity markets this year, yet we find the current disconnect between the outlook for the economy and profits increasingly difficult to ignore. Against this backdrop of conflicting signals, we think equity portfolios should emphasize companies with durable quality attributes—strong balance sheets, sturdy pricing power, reliable cash flows, and sustainable dividends—as they tend to be better positioned to weather tougher economic conditions.
A perplexing dichotomy between economic and earnings forecasts
Global real GDP growth consensus forecast (y/y) (left); MSCI All-Country World Index consensus EPS estimate (right)
Side-by-side bar charts showing market expectations for global real GDP growth and earnings per share for the MSCI All-Country World Index for Q3 2022 through Q4E 2023 period. The charts highlight a divergence in the projections for the economy versus earnings, whereby economists are projecting a material slowdown in global economic growth through the end of the year while analysts are forecasting a strong recovery in earnings.
Source - RBC Wealth Management, Bloomberg; data through 5/19/23
With the rate-hike cycles of major central banks drawing to a close, we maintain a constructive stance towards fixed income as bonds have historically performed well following a peak in rates. While bond yields have declined in recent months in anticipation of central banks moving to the sidelines, we believe they are still at levels that offer appealing entry points for investors thanks to the substantial upward repricing over the past year. The opportunity set across corporate bond markets remains compelling, in our view, with many segments offering attractive all-in yield (return) profiles that present reasonable alternatives to achieving mid-to-high single-digit returns over the medium term.
Relative value continues to favour fixed income
Risk premiums across major asset classes
Side-by-side bar charts showing market expectations for global real GDP growth and earnings per share for the MSCI All-Country World Index for Q3 2022 through Q4E 2023 period. The charts highlight a divergence in the projections for the economy versus earnings, whereby economists are projecting a material slowdown in global economic growth through the end of the year while analysts are forecasting a strong recovery in earnings.
Note: Earnings yield is the inverse of the forward price-to-earnings ratio. Bond yield refers to yield to worst for the Bloomberg U.S. Corporate Index, the Bloomberg Global Agg Credit Index, the Bloomberg U.S. Corporate High Yield Index, and the Bloomberg Global Corporate High Yield Index.
Source - RBC Wealth Management, Bloomberg; data through 5/19/23