As stocks took a blistering dive this week, Wall Street economists scrambled to readjust their forecasts of the likelihood that the economy is headed for another recession. In a matter of days, a consensus quickly emerged: Most strategists now place the odds of a double dip at 30-40%.
Goldman Sachs’ (GS) chief economist recently announced that there was a one-in-three chance that there will be another recession in the next nine months. The economists at both Standard & Poor’s (who work separately from the ratings division) and Bank of America Merrill Lynch (BAC) moved their recession meters to 35%. Deutsche Bank (DB) aimed a little higher, placing its estimate at 40%.
Bob Doll, the chief equities strategist at BlackRock (BLK), announced Wednesday that the asset management giant sees a 30% chance of a recession. “We don’t anticipate a vigorous economic cycle, but we are not arguing for recession either,” he wrote.
Given the current mania in the markets, such prognostications, while far from cheery, are still comforting: The strategists agree that the economy probably won’t double dip. But as the oddsmakers weigh in, it’s important to remember that they didn’t exactly hit the ball out of the park the last time around.
The last recession officially started in December of 2007, according to the National Bureau of Economic Research. In January of 2008, economists surveyed by Bloomberg put the likelihood of a recession at 40%. That February, they lifted the odds to 50%–and then left them there for months (there was a brief spike in April, after Bear Stearns went under). In early September, just days before Lehman Brothers collapsed and the stock market imploded, economists still placed the probability of a recession at just 51%.
Reacting with the pack
What’s incredible about those odds is the speed at which they changed. That October, economists declared a 90% chance that a recession was coming (by then, you’d have to be a cave-dweller to think otherwise).
The latest revisions are similarly drastic. This June, forecasters saw a mere 15% chance of a recession; in July, that number actually dipped to 13.8%. As more and more economists roll out their (uncannily similar) estimates in the 30-40% range, it seems likely that August’s survey will show a marked increase.
In both 2008 and today, economists modified their estimates in a reactionary fashion: Both revisions occurred after the stock market had already tanked. In each case, the market caught strategists by surprise, and strategists adjusted their forecasts in response to the dips.
Does that mean the tail, i.e. The market, is wagging the dog? The revisions themselves are justified; market crashes, which can destroy trillions of dollars in corporate and personal wealth, can amplify recessionary factors.
“One of the problems with many recessions is that they’re triggered by unexpected events,” says Gustavo Grullon, a professor at Rice University’s school of business. Grullon points out that the oil crisis in the 1970’s and the financial crisis in 2008 caught many forecasters by surprise. “Economists are having trouble because most of those events are really unpredictable,” he says.
But the magnitude — and velocity — at which strategists adjust their estimates after stocks crash renders the practice of oddsmaking suspect. Economists react strongly to the market — but Doll pointed out that there have been 30 market declines of 15% or more since the Great Depression, and that only two led to recessions.
Indeed, many of the events that precipitated the latest crash — the downgrading of U.S. Debt, the political gridlock in Washington, and the European sovereign debt crisis — have been unfolding for months. Economic indicators have also been dreadful. Hiring and consumer spending both took a dip this summer. So did manufacturing activity. GDP growth hasn’t turned negative — the rule of thumb is that two quarters of negative growth signify a recession — but the economy grew last quarter at a paltry 1.3%.
Bond investors, meanwhile, have piled into Treasuries and fled speculative debt. Junk bond spreads now signal a 48% chance of a recession, according to Martin Fridson, global credit strategist at BNP Paribas Investment Partners. Fridson went on to add that the spread meant that high yield bonds had probably fallen too much.
Most forecasters still maintain that a second recession is unlikely. BlackRock’s Doll wrote that it would be rare for a recession to begin while initial unemployment claims were declining. He contrasted the current environment with the situation in 2008, when even the price of gold was declining, signifying a “deflationary debt problem.” The rise in gold prices today, he said, indicates that investors expect another stimulus. Doll advised investors to put their cash to work in the market.
Not all economists agree. One strategist who has veered from the pack is Gluskin Sheff’s David Rosenberg, the market Cassandra who said in January of 2008 that the economy was already in a recession. In a recent note, Rosenberg mocked the new consensus. “You cannot be sort of pregnant any more than you can maybe, perhaps, be in a recessionary state,” he wrote.
“The bond market also clearly has recession in its sights,” added Rosenberg, who told Coins2Day in June that there was a 99% chance of a double dip. “None of this namby pamby ‘35% odds’ stuff out of Wall Street.”