*Based on slope of yield curve (10-year yield minus 3-month yield) and inflation-adjusted oil price.
Data through October 2022, projecting probability 12 months forward to October 2023.
An increasingly hawkish Fed and persistent inflation continue to challenge markets, and we now expect a mild economic recession in 2023. The key driver is a Fed that moves interest rates into increasingly restrictive territory, putting a pinch on business capital expenditures and consumer spending. The inversion of the yield curve along with an elevated oil price show a rising probability of recession in our model, which fits with our other analyses, qualitative judgement, and signals in corporate earnings guidance and surveys of CEO sentiment. We expect a deceleration in inflation going forward, but not quickly enough for the Fed to slow hikes soon nor reduce rates significantly in 2023.
Despite our expectation of a mild recession, we are not moving to a more defensive posture in portfolios. Equities could see further downside and continued choppiness into next year. If the mild recession does indeed transpire, we would expect a decline of 10%–15% for U.S. large-cap equities, down roughly to the lows registered in mid-October of this year. However, it is incredibly difficult to time the market. Significantly reducing risk from equities requires timing not only the exit from but also the return to the equity market. History tells us that the equity market will bottom before the backdrop improves in a convincing manner. In fact, it is common for the equity market to bottom early in or even just before the onset of a recession. The bounce off the bottom is often violent, and missing these strong days can significantly detract from long-term wealth creation. We are staying invested but looking for opportunities across regions (favoring the U.S. over international developed) and factors (tilting slightly toward growth, quality, and lower volatility). Should the market move sharply higher or lower without a commensurate change to our view of the risks, we will adjust portfolios accordingly.
S&P 500 index measures the stock performance of 500 large companies listed on stock exchanges in the U.S. and is one of the most commonly followed equity indices.
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