Recession Looms: Stocks Unprepared, ISM Below 50 Signals Risk

Key Takeaway

• US recession risk is increasing, with deteriorating soft data and fragile hard data suggesting a potential shift towards a downturn.
• Stocks are not priced for a recession, facing vulnerability as expectations of the Fed's rate cuts may not align with an economic slump.
• Manufacturing ISM dropped below 50 in April, signaling weakening economic conditions that could lead to more volatile stock prices and lower bond yields.

Recession Risk Revisited

As we navigate through the complexities of the current economic landscape, the specter of a US recession looms larger once again. Recent weeks have seen a notable deterioration in soft, survey-based data, while hard, factual data remains fragile. This shift has prompted a reevaluation of recession expectations, which, although currently low, could rapidly escalate. The stock market, seemingly unprepared for a downturn, and bond yields, which are anticipated to decline in the coming months, are central to this narrative.

The nature of recessions, akin to the S curve's abrupt transitions, suggests we are on the cusp of moving from a low to a high probability of a downturn within the next 3-4 months. This potential shift is critical, as stocks typically face their most significant challenges during recessions, and are not currently priced for such an eventuality. The manufacturing ISM, a key economic indicator, has recently fallen below 50, signaling a contraction in new orders relative to inventory, a precursor to economic slowdowns.

Stock Market and Rate Cuts

The stock market's current trajectory implies an expectation of a soft landing, possibly anticipating the Federal Reserve's rate cuts in the absence of a recession. However, history shows that rate cuts during slumps often precede worse outcomes for equities. This discrepancy between expectations and potential reality underscores the market's vulnerability to a sudden shift in recession risk. With the manufacturing sector's new orders-to-inventory ratio declining, and the services ISM also dipping below 50, the signals for caution are becoming increasingly clear.

Hard and Soft Data Signals

The interplay between hard and soft data is crucial for understanding recession risks. While growth in leading hard-data indicators has shown some improvement, it remains in contraction territory. Simultaneously, leading soft-data indicators are teetering on the edge of contraction. This precarious balance highlights the potential for a swift move towards recession, exacerbated by the possibility of significant data revisions that could further underscore the downturn's onset.