Is A Recession Coming Soon?

The headline may seem like a rhetorical question for some because so many investors appear to believe that a recession isn’t far off. Oil prices have been volatile, China’s economy is taking a huge hit, and the fourth quarter earnings season is projected to be the worst reporting season in years. Indeed, all these issues suggest that the world’s equity markets are heading into a deflationary recession, although some of the signs appear to contradict each other.

Nonetheless, the equity markets are driven by investors’ perceptions, so just the belief that a recession is near has been enough to trouble the markets.

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Investors widely expecting a recession

In a report dated Jan. 22, Goldman Sachs analyst David Kostin and team noted that the markets in general have corrected swiftly over the last few weeks and that this indicates that equity investors are focused on the possibility of a recession this year. The causes of this problem include plunging oil prices and weakness in industrial activity. Add China into the mix, and you have the potential for dire circumstances.

Despite all these problems, economic data from the U.S. hasn’t changed much since the S&P 500 surpassed 2100 early last month, the Goldman team added. The index climbed 1.4% last week with the Telecommunications Services sector being the best-performing sector and Financials the worst-performing. Goldman expects the S&P to return to 2100 in 12 months, which would represent an increase of 10.1%.

Although most investors are expecting a recession, naturally there are some who aren’t. The Goldman team suggests that the recent correction presents a buying opportunity for those who don’t expect a recession. For those who do expect a recession this year, they recommend focusing on companies with strong balance sheets and domestic revenue exposure because they believe their stocks will outperform even if a recession occurs.

Conflicting recession signs from the PMI

S&P Capital IQ examined the industrial Purchasing Manager Index (PMI) and the PMI for the service sector in the U.S., Europe and China and found conflicting signs. For example, the average manufacturing PMI for all three regions fell to 50.4 at the end of the year from 50.7 in September, which was when forward S&P 500 earnings began to fall.


Additionally, the firm reports that the average services PMI has gotten stronger and stabilized within a range of 54.6 to 55.4 at the end of the year. Since April 2014, it has remained above the average of 52 to 54 between 2012 and 2013.


Earnings probably won’t save the markets

So what if fourth quarter earnings end up being better than expected? S&P Capital said there’s still plenty of bad news to go around. If applying the average beat rate of four percentage points to the fourth quarter, earnings will still be declining, marking the first time since 2009 that the markets say two declines in consecutive quarters.

And what’s worse, this year is expected to see a 4.7% decline in profits for the S&P 500 and the forward price to earnings ratio could fall to 15.1 times. As of the end of the third quarter, it was at 16.4.