A Recession Isn’t Inevitable. But Europe’s Concerns Are Real

n ugly word has been shooting around the media like it’s going out of fashion: Recession, usually defined as two back-to-back quarters of a shrinking economy.

Judging by recent headlines and rhetoric from experts, you’d think we are already there. As with many things in life, truths are more complicated. A recession is something that no human being wants. This happens because periods of low unemployment often coincide with high levels of corporate profits and greater unemployment.

There are increasing risks that there will be a global recession, but the likelihood of one occurring in the U.S. or Asia is lower than it being in Europe.

At the moment, we are seeing a deceleration in global economic activity. “In a slowing economy, investors get anxious because that R-word may be right around the corner,” says Amanda Agati, chief investment officer at PNC Asset Management Group.

The source of fear

The current worries aren’t just investor paranoia, however. First-quarter economic growth in the U.S.—the world’s largest economy—slowed to 3.5%, down from 5.5% during the last three months of 2021. As part of the war against rising prices, the Federal Reserve enacted its largest interest rate increase in almost thirty years. Recent inflation rose to 8.6% annually, an increase of 5.3% from August.

A primary issue for investors is the Fed’s historic lack of skill in reducing inflation while avoiding a recession. “The Fed has never orchestrated a soft landing once after completing a tightening cycle,” Agati says. Indeed, the Fed’s inability to effectively get its timing right may be the biggest risk.

Yet, optimism is a strong factor. “We don’t see the probability of a recession in 2022,” Agati says. “We think the economy holds up,” She sees a mere one-in-three chance of a U.S. recession next year.

Don’t let your worries get out of control

It makes sense to some other economic watchers. They see many signs that indicate strength, but also perceive risks that may be overblown.

Investors are not surprised by the weak stock market. So far this year, the S&P 500 index lost more than 20%, ushering in a bear market. This dramatic decline in stock markets could indicate a possible recession. But it doesn’t always. Stocks fell by more than 20% one day in October 1987. It was not a time of imminent recession. Late 2018, that same index saw a nearly 20% decline. Again, no recession followed. Similar declines, but less severe, occurred in 2015, as well as the middle of 2011 and 2012 respectively, with no subsequent recessions.

A second concern is likely to be the softening of the U.S. housing markets. The U.S. saw a drop in sales of homes, dropping to 591,000 per year in April from 831,000. In January, the figure was 831,000. While that doesn’t sound good, the slowdown likely won’t be prolonged or severe, experts note.

In the past decade, home builders built fewer homes than needed to meet the growing population and replace dilapidated buildings. This means that there will be an almost certain rebound in real estate demand. “It is universally agreed that we have a housing shortage,” says Jay Hatfield, CEO of Infrastructure Capital Management. “We don’t think housing goes into a death spiral.”

The U.S. economy is unlikely to grow at the rate it did in recent months due to the slowdown in homebuilding. This isn’t the same thing as a six month-long contraction of all sectors, which can be described as a recession. “We see a slowdown,” says Thomas A. Martin, Senior Portfolio Manager at Globalt Investments in Atlanta.

Hidden Bright Spots

The employment market remains vibrant. “Employment remains strong,” Martin says. Recent monthly employment reports show that 390,000 new jobs were created in May by the United States. This was more than any growth in the number of workers. The unemployment rate was at an all-time low of 3.6%.

That’s the opposite of typical recession news. The peak pandemic-driven recession was April 2020. In April 2020, there was 14.7% unemployment, an increase of 4.4% from the prior month.

Corporate profits are often hit hard by recessions. Wall Street predicts the contrary. New York-based investment bank Goldman Sachs is currently predicting an increase in earnings for the companies in the S&P 500 index of 8% this year and 6% in 2023.

U.S.’s energy sector is also flourishing. Consumers are contending with higher gas prices, but at the same time, the U.S. is exporting liquified natural gas to Europe to supplement now-reduced energy supplies following Russia’s invasion of Ukraine.

Chinese recovery

There are also positive signs outside the U.S. China, the world’s second-largest economy and the driving economic force in Asia, looks likely to see a growth burst following temporary COVID-19-related lockdowns. Reportedly, annual growth fell to 4.8% during the first quarter from 18.3% the year prior.

“I expect growth to recover, and they have all the means to cut rates and use fiscal measures,” says Adrien Pichoud, chief economist at Syz Bank. He expects Chinese growth to be strong, meaning it won’t be in recession. According to him, China’s economy should stabilize after the recovery from the lockdown. It will probably see an annual growth rate of between 5% and 5.5%. “If China stabilizes it will be good for the rest of Asia.”

Europe’s Real Problems

Europe is an entirely different story. One-currency zone known as the Eurozone receives government assistance in order to cope with spiralling food and energy prices. This amounts to approximately 1% of the GDP. “We’re not talking small numbers here,” Pichoud says.

However, subsidies are likely to end 2023. As Europe suffers from severe energy shortages, this raises the chance of European recession. “We may face an environment where momentum is softer, and the headwinds of tighter financing raise the risk of recession,” Pichoud says.

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